Private Pensions: Funding Rule Change Needed to Reduce PBGC's
Multibillion Dollar Exposure (Letter Report, 10/05/94, GAO/HEHS-95-5).
In 1990, GAO flagged 17 federal programs areas as "high risk," including
the Pension Benefit Guaranty Corporation (PBGC), which is plagued by a
large and growing deficit and a large exposure to potential claims from
underfunded plans. PBGC recently reported that underfunding in the
single-employer defined-benefit plans it insures grew from $38 billion
in 1991 to $53 billion in 1992--this despite more stringent funding
requirements that the Pension Protection Act mandated for underfunded
plans in 1987. GAO concludes that the current funding rules for
underfunded plans are not working well. Despite the act's intent that
funding in underfunding plans be improved, most sponsors of underfunded
plans made no additional contributions to reduce underfunding in 1990.
This is partly due to an unanticipated design flaw that yields offsets
that are too large for many plans. In addition to describing the act's
weaknesses in reducing underfunding, this report describes the potential
impact of the proposed Pension Funding Improvement Act of 1993 and the
Administration's proposed Retirement Protection Act of 1993 on improving
plan funding.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: HEHS-95-5
TITLE: Private Pensions: Funding Rule Change Needed to Reduce
PBGC's Multibillion Dollar Exposure
DATE: 10/05/94
SUBJECT: Pension plan cost control
Employee benefit plans
Financial institutions
Offsetting collections
Retirement pensions
Liability (legal)
Funds management
Financial management systems
Proposed legislation
IDENTIFIER: Pension Fund Improvement Act of 1993
Retirement Protection Act of 1993
GAO High Risk Program
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Cover
================================================================ COVER
Report to the Subcommittee on Oversight, Committee on Ways and Means,
House of Representatives
October 1994
PRIVATE PENSIONS - FUNDING RULE
CHANGE NEEDED TO REDUCE PBGC'S
MULTIBILLION DOLLAR EXPOSURE
GAO/HEHS-95-5
Funding Private Pensions
Abbreviations
=============================================================== ABBREV
DRC - deficit reduction contribution
ERISA - Employee Retirement Income Security Act
FSA - Funding Standard Account
IRS - Internal Revenue Service
OBRA 87 - Omnibus Budget Reconciliation Act of 1987
PAYGO - pay-as-you-go
PBGC - Pension Benefit Guaranty Corporation
PFIA - Pension Funding Improvement Act of 1993
PPA - Pension Protection Act
RPA - Retirement Protection Act of 1993
SMR - solvency maintenance requirement
URR - underfunding reduction requirement
Letter
=============================================================== LETTER
B-250346
October 5, 1994
The Honorable J. J. Pickle
Chairman, Subcommittee on Oversight
Committee on Ways and Means
House of Representatives
Dear Mr. Chairman:
In 1990, we began a special effort to review and report on federal
government program areas that we considered "high risk." We
identified 17 such program areas. One was the Pension Benefit
Guaranty Corporation (PBGC), which was included because of its large
and growing deficit and the large exposure (potential claims) it
faces from underfunded plans.
PBGC recently reported that underfunding in the single employer
defined benefit plans it insures grew from $38 billion in 1991 to $53
billion in 1992. The underfunding increased despite the more
stringent funding requirements for underfunded plans that were put in
place by the Pension Protection Act (PPA) in 1987.\1
Because of your concern about pension promises being funded, you
requested that we analyze (1) the efficacy of the PPA provisions in
reducing underfunding and (2) the potential impact of the proposed
Pension Funding Improvement Act (PFIA) of 1993 (H.R. 298/S. 105)
and the administration's proposed Retirement Protection Act (RPA) of
1993 (H.R. 3396/S. 1780) on improving plan funding.
--------------------
\1 The PPA was a part of the Omnibus Budget Reconciliation Act of
1987.
BACKGROUND
------------------------------------------------------------ Letter :1
The Employee Retirement Income Security Act of 1974 (ERISA) was
enacted to protect the benefits of participants in defined benefit
pension plans.\2 Before ERISA, many plan participants lost promised
benefits when their underfunded pension plans terminated.
ERISA created the PBGC to insure the pensions of participants in
defined benefit plans. When an underfunded insured plan terminates,
PBGC trustees the plan and becomes responsible for paying guaranteed
benefits to its participants.
ERISA also established minimum funding rules for defined benefit
pension plans. The minimum funding contribution comprises two
amounts--normal cost (the cost of benefits allocated to the current
year) and an amount to reduce the plan's unamortized liabilities (see
app. I). The latter amount is the net of charges to amortize
sources that increase underfunding less credits to amortize factors
that reduce underfunding.
Because of PBGC's growing deficit and continued underfunding in many
plans, the Congress passed the PPA in 1987. The PPA was designed to
improve plan funding and protect PBGC from growing deficits. Among
the PPA provisions to improve plan funding was a new additional
contribution requirement for sponsors of large (101 or more
participants) underfunded plans.\3
Under the additional contribution requirement, sponsors of large
underfunded plans must calculate an additional contribution amount.
This contribution can be reduced by subtracting specified components
of the plan's minimum funding contribution under ERISA. We call this
amount the "offset." The offset provision is designed to give credit
for payments the sponsor is already making in its minimum
contribution to reduce the plan's underfunding.
Despite the PPA changes, many large plans remain underfunded, with
underfunding increasing in some, and PBGC's deficit and level of
exposure continue to grow. We have testified that to reduce PBGC's
exposure, and ultimately its deficit, plan funding should be
improved.\4
Improving the funding in underfunded plans should benefit the
following parties: plan participants, who may lose some of their
pension benefits should their underfunded plan terminate; PBGC, which
faces exposure to the risk of terminated pension plans; sponsors of
financially sound plans, who may otherwise see their PBGC premiums
increase to offset PBGC's growing losses; and taxpayers, who may have
to pay should PBGC exhaust the assets it has for paying its
obligations.
Lawmakers introduced several pieces of legislation in the 102nd
Congress to increase contributions from sponsors of underfunded plans
and to improve PBGC's financial condition, though none was enacted.\5
Currently, the Congress is considering the PFIA and the RPA.
The PFIA would eliminate the current additional contribution
provision and require a minimum contribution equal to the greatest of
three alternatives--the current funding rules without any additional
contributions (ERISA requirement), rules based primarily on plan
disbursements (solvency maintenance requirement or SMR), and rules
based primarily on the plan's funding ratio (underfunding reduction
requirement or URR).
The RPA would strengthen current law funding provisions and add a
requirement that plan liquid assets equal at least 3 years'
disbursements. (See app. I for a detailed explanation of the
funding and other provisions contained in the PFIA and RPA.)
We used a PBGC data file to select a random sample from the 4,968
large plans paying the PBGC variable rate premiums in 1990. We used
this sample to determine how current funding rules affect underfunded
plans and how provisions in the PFIA and RPA would affect them.
Fifty-seven of the 93 plans in our sample had unfunded current
liabilities in 1990 and were subject to the additional contribution
provision of PPA.\6 These 57 plans project to a population of 3,045
underfunded large plans.\7 (See app. II for details of our scope and
methodology.)
--------------------
\2 ERISA also provides certain protections for participants in other
pension and welfare benefit plans.
\3 Plans with fewer than 101 participants are not subject to the
additional contribution provision of PPA.
\4 Assessing PBGC's Short-Run and Long-Run Conditions
(GAO/T-HRD-93-1, Feb. 2, 1993).
\5 These bills were S. 2014, S. 2485, S. 3162, H.R. 3843, H.R.
4545, and H.R. 5800.
\6 Thirty-three of the 93 plans in our sample were not underfunded on
a current liability basis. Three additional plans were exempt from
making additional contributions. (See app. III.)
\7 The confidence interval is plus or minus 523 plans.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :2
The current funding rules for underfunded plans are not working well.
Despite the PPA's intent that funding in underfunded plans be
improved, sponsors of most underfunded plans in our sample made no
additional contributions to reduce underfunding in 1990.
Although the PPA requires sponsors of all underfunded plans to
calculate an additional contribution amount, it also allows this
contribution to be reduced or offset. In 1990, these offsets
eliminated the additional contribution for 60 percent of the
underfunded plans in our sample and substantially reduced them for
another 30 percent.
Plan sponsors in our sample paid less than 10 percent of the
originally calculated additional contribution amount to their
underfunded plans, and these contributions reduced total underfunding
in the plans receiving them by less than 3 percent. As a result, the
additional contribution provision advanced few underfunded plans
toward full funding.
Our examination of the current additional funding rules revealed a
design flaw in the offset that makes it too large for many
underfunded plans. However, simply correcting that flaw will not
result in additional contributions from sponsors of many underfunded
plans. For many plans, the offset will continue to eliminate any
additional contributions.
The proposed PFIA would actually reduce the percent of sponsors
making increased contributions to their underfunded plans. However,
the PFIA would cause substantial increases for the few sponsors
affected by its solvency maintenance provision.
The administration's proposed RPA would increase the percentage of
underfunded plan sponsors making additional contributions to about 50
percent. Affected sponsors would make sizable additional
contributions; however, the increases would not be as large as those
of sponsors paying under PFIA's solvency maintenance rule. In our
opinion, the RPA moves in the right direction to strengthen funding
in underfunded plans.
However, our analysis indicates that about half the sponsors of
underfunded plans will not make additional contributions if the RPA
is enacted as it stands.\8 For this reason, we believe that changes
to current funding rules beyond those proposed in RPA should be
considered to protect PBGC and plan participants from the
consequences of underfunded plan terminations. The rules would need
to balance such changes with the budget's pay-as-you-go (PAYGO)
requirements.\9
--------------------
\8 The 95-percent confidence interval indicates that between 39 and
65 percent of underfunded plans would receive additional
contributions under the RPA.
\9 Under the Budget Enforcement Act, PAYGO requires that all direct
spending and tax legislation enacted during a session of the Congress
must be deficit-neutral in the aggregate.
CURRENT RULES DO LITTLE TO
REDUCE UNDERFUNDING
------------------------------------------------------------ Letter :3
Sponsors of 34 of the 57 plans in our sample that had unfunded
current liabilities made no additional contributions in 1990 because
of the size of their offsets. And the offsets substantially reduced
the additional contributions for 16 of the 22 sponsors that made them
(see app. III).\10 \11
Forty-five of the 93 plans in our sample were so-called flat benefit
plans.\12 Flat benefit plans are more likely than other plans in our
sample to have unfunded current liabilities (34 plans versus 23) but
less likely to be receiving additional contributions from their
sponsors (9 plans versus 13). The 1990 additional contributions were
equivalent to 2.6 percent of underfunding in our sample plans that
received them--11 percent of the underfunding in the nonflat benefit
plans but only about 1.5 percent in the flat benefit plans. This
difference is caused in large part by the greater offsets available
to flat benefit plans.
The offset has a powerful effect, in part, because of a design flaw.
The offset is intended as a credit for the payment the sponsor is
already making to reduce underfunding through ERISA's minimum funding
requirement. However, the offset includes only a subset of the
plan's amortization charges and credits--the components of this
payment. For most plans in our sample, the offset included most
amortization charges and ignored most amortization credits. Thus,
for most plans, the offsets were larger, often much larger, than
payments the sponsors were actually making in their minimum funding
contributions to reduce plan underfunding. Additional contributions
were reduced or eliminated in these plans as a result.
The offset could be corrected by setting it equal to the underfunding
reduction payment in the minimum funding contribution--the difference
between the total amortization charges and the total amortization
credits. In our sample, using this modified offset would have
increased the number of plan sponsors making additional contributions
in 1990 from 22 to 32 (20 of the 32 would have been sponsors of flat
benefit plans). Total additional contributions would have increased
from $2.8 million to $19.9 million.
Even with this modification, however, sponsors of many underfunded
plans, including some of the most underfunded, would not be required
to make any additional contributions to improve their plans' funding
(25 of the 57 underfunded plans in our sample). As a result, this
modification alone would not diminish PBGC's exposure to the
underfunding in many underfunded plans.
The additional contribution provision will need additional changes if
sponsors of most underfunded plans are to speed up their plans'
funding. This could be accomplished in various ways. For example,
restricting offsets to be no greater than 50 percent of the
additional contribution before offsets would cause sponsors of all
underfunded plans to make additional contributions. In our sample,
the sponsors of the 57 underfunded plans would make $23.5 million in
additional contributions.
Because pension contributions are a tax deductible expense, any
increase in contributions will cause a decrease in federal revenues,
and PAYGO restrictions will apply. The revenue loss from the
increased additional contributions would have to be offset by other
new revenues or by expenditure cuts.
--------------------
\10 One sponsor should have made an additional contribution but did
not because it misinterpreted Form 5500 (Annual Return/Report of
Employee Benefit Plan) instructions.
\11 The 22 sponsors making additional contributions represent
sponsors of 1,175 (plus or minus 460) of the approximately 3,045
plans subject to the additional contribution provision.
\12 In these plans, monthly benefits are determined by multiplying
years of service by a specified dollar amount (for example, years of
service times $20).
THE PFIA COULD REQUIRE
EXCESSIVE CONTRIBUTIONS
------------------------------------------------------------ Letter :4
Our analysis of the plans in our sample indicates that the funding
provisions proposed in PFIA--contributions equal to the greatest
amount calculated under three different methods--would have reduced
the number of sponsors of underfunded plans making increased
contributions in 1990. However, the provisions would have
substantially increased the amount of contributions affected sponsors
would have paid.
Sponsors of 59 plans in our sample would be subject to the funding
rules under PFIA,\13 but only 16 sponsors would make contributions
that exceed the current ERISA minimum contribution, compared with 22
under current law. However, under PFIA, total contributions for
sponsors of these 16 plans would increase by $44.7 million, from
$17.4 million under the ERISA minimum contribution requirement to
$62.1 million (see app. IV). Compare this with $2.8 million in
additional contributions for 22 sponsors under current law.
The PFIA contains a proposed offset provision that, in our opinion,
is unnecessary and would effectively exempt many sponsors from making
increased contributions. Without this proposed offset provision, 43
of the 59 sponsors would be required to make increased contributions.
Total required contributions for these 43 sponsors would more than
quadruple--from $31.2 million under the ERISA provision to $126.7
million.
Most of the increase in contributions, whether the proposed offset
provision is in effect or not, would come from sponsors that would
contribute under the PFIA's SMR. This requirement would cause
benefits and other disbursements to be paid from current cash flow
rather than from plan assets, no matter how well funded the plan is.
Thus, although the proposed SMR would be an especially powerful tool
for increasing plan funding, we have concerns about this provision.
In our opinion, the proposed SMR is overly punitive. Because each $1
of benefit payments decreases both plan liabilities and assets by $1,
only the unfunded portion of disbursements needs to be replaced to
maintain the plan's funding ratio. Requiring full replacement of
disbursements will have a greater impact on plans with high funding
ratios (the better funded underfunded plans) than on plans with low
funding ratios. Also, as written, this provision could pose a severe
hardship for financially troubled sponsors with cash flow problems.
--------------------
\13 PFIA restrictions on the allowable range of interest rates to be
used when calculating current liabilities would cause two additional
plans to have unfunded current liabilities.
THE RPA OF 1993 ADDRESSES THE
OFFSET PROBLEM BUT IS NOT A
COMPLETE SOLUTION
------------------------------------------------------------ Letter :5
The RPA contains several provisions that would improve the current
law funding rules. It would add a solvency rule, which would require
plan liquid assets to equal at least 3 years' worth of plan
disbursements,\14 and would address the offset design problems. The
solvency rule would increase assets for one plan in our sample (see
app. V). As with the PFIA, additional contributions under the RPA
would increase for sponsors making them, but almost 50 percent of
underfunded plan sponsors would not initially make additional
contributions under the proposal.
The RPA would address the flaw we found in the current law offset by
including all amortization charges and credits in the offset.
However, it would also include the plan's normal costs in the offset.
In our sample, including normal costs in the offset would result in
fewer sponsors making additional contributions than if normal costs
were not included.
Two transitional limitations proposed in the RPA would restrict the
size of the additional contribution through the 2001 plan year.
Without these limitations, 38 of the sponsors in our sample, almost
60 percent of the 65 subject to the additional contribution
provisions under RPA, would make $29.2 million in additional
contributions.\15 The transitional limitations would eliminate the
additional contribution for 4 of these 38 sponsors and reduce them
for 11 others. With the limitations in place, 34 sponsors would make
additional contributions of $28.0 million.
In 1990, the proposals contained in the RPA would have affected only
about half the sponsors in our sample. All plans in our sample that
were less than 50-percent funded would have received additional
contributions. However, sponsors of about half the plans with
funding ratios between 50 and 80 percent would not have been required
to make additional contributions because offsets would have continued
to eliminate their additional contributions.
The goals of the RPA are to improve pension plan funding and limit
the growth in PBGC insurance exposure. Our analysis indicates that,
if the RPA had been in effect in 1990, only about half of all
underfunded plans would have improved funding. Neither the
underfunding in the remaining plans nor the risk these plans pose to
PBGC would have been reduced. We conclude that additional
strengthening of the additional contribution provision, beyond that
contained in the RPA, is necessary to ensure that sponsors of most
underfunded plans make additional contributions to improve their
plans' funding.
--------------------
\14 Liquid assets are defined in the RPA as cash, marketable
securities, and other assets specified by the Secretary of the
Treasury.
\15 Restrictions on both the interest rates and mortality table that
could be used to calculate plan liabilities would increase the number
of plans subject to the additional contribution provision to 65
(compared with 57 under current law).
CONCLUSIONS
------------------------------------------------------------ Letter :6
The current rules to improve funding in underfunded plans did not
result in additional contributions from most sponsors of underfunded
plans in 1990. In part, this is due to an unanticipated design flaw
in the current offset that yields offsets that are too large for many
plans. Modifying the offset design to correct the flaw will increase
both the number of sponsors making additional contributions and the
amount of such contributions. This is an important first step.
However, on the basis of our analysis, the modified offset would have
continued to eliminate any additional contributions for sponsors of
about half the underfunded plans in 1990. We believe more of these
sponsors should make additional contributions and, therefore,
additional steps are needed.
The proposed legislation in the PFIA would reduce the number of
sponsors making increased contributions compared with current law.
The RPA would increase both the number of plans subject to the
additional contribution provisions and the average additional
contribution for sponsors making them, but would not require sponsors
of many underfunded plans to make additional contributions. Based on
our random sample of underfunded plans, only about 50 percent of the
sponsors of underfunded plans would have done so in 1990.
While we believe that the RPA would help strengthen funding, changes
to the current funding rules beyond those proposed in either the PFIA
or the RPA are necessary to improve funding in most underfunded
plans. We believe that the Congress should consider such additional
changes to protect PBGC and plan participants from the consequences
of underfunded plan terminations.
Any changes to the RPA that increase contributions from sponsors of
additional underfunded plans will also reduce federal revenues
because these new contributions will be a tax deductible expense for
plan sponsors. We believe the incremental revenue loss from
modifying the RPA would be small and would be a modest price to pay
for the reduced exposure to PBGC and risk of benefit loss to plan
participants. PAYGO requires that any lost revenue be offset by
other revenue-generating measures or expenditure cuts. The Congress
would have to balance the budget's PAYGO considerations with the
improved protections for PBGC and participants in underfunded plans,
however.
MATTERS FOR CONSIDERATION
------------------------------------------------------------ Letter :7
In view of the persistent and growing underfunding in pension plans
insured by PBGC, the Congress should consider redesigning funding
standards to bolster contributions for underfunded plans. Many
provisions in the RPA, such as the solvency rule, the offset
redesign, and the immediate recognition of benefit increases, should
be included in any new legislation.
In addition, the Congress may wish to consider limiting the amount of
offset that can be used to reduce the additional contribution, thus
increasing the percentage of underfunded plans receiving such
contributions. If this offset were limited to 80 percent of the
initially calculated additional contribution, for example, then
sponsors of each underfunded plan would make a contribution in
addition to the minimum contribution required under ERISA of at least
20 percent of the initially calculated additional contribution
amount. If the Congress wants to exempt almost fully funded plans
from this automatic funding requirement, it should consider applying
the requirement only to plans with funding ratios below a specified
threshold. These changes would have to be made in accordance with
the budget's PAYGO requirements.
AGENCY COMMENTS AND OUR
EVALUATION
------------------------------------------------------------ Letter :8
In commenting on a draft of this report, PBGC's Executive Director
agreed with our findings. However, he does not believe the RPA needs
to be strengthened to require that sponsors of additional underfunded
plans make an additional contribution. He acknowledges that some
underfunded plans would not be required to make additional
contributions under the RPA provisions and states that this
"represents a considered approach on the Administration's part." He
believes that most underfunded plans not affected by the RPA's
provisions "will progress toward full funding at a satisfactory pace
under current law" and "should not be burdened with an unnecessary
requirement." He points out that our proposed strengthening of the
RPA was not based on a long-term analysis of the projected impact on
funding in these plans. Finally, he indicates that the agency will
reexamine the transitional phase-in rules in light of our comments
and those of others.
Both PBGC and GAO recognize that problems exist in current
regulations affecting pension plan funding. Both agree that action
must be taken to solve these funding problems, but we in GAO believe
action stronger than that proposed in the RPA is necessary for these
problems to be eliminated. Sponsors of 31 underfunded plans in our
sample would not make additional contributions under RPA. Fifteen of
these plans are less than 80 percent funded. Our analysis indicates
that, for 2 of these 15 plans, the portion of the sponsor's
contribution designed to reduce underfunding would not be sufficient
to amortize this underfunding over a 20-year period. Therefore, we
do not consider that these two plans are satisfactorily progressing
toward full funding. In our view, a mechanism stronger than those
proposed in the RPA is necessary to move all underfunded plans to
full funding in a timely manner.
---------------------------------------------------------- Letter :8.1
We are sending copies of this report to the Executive Director of the
Pension Benefit Guaranty Corporation; the Secretaries of Labor, the
Treasury, and Commerce in their capacities as Chairman and Members of
the Board of Directors of the Pension Benefit Guaranty Corporation;
the chairmen of interested committees and subcommittees; and the
Director of the Office of Management and Budget. Copies will be made
available to others upon request.
Sincerely yours,
Joseph F. Delfico
Director, Income Security Issues
FUNDING PROVISIONS FOR DEFINED
BENEFIT PENSION PLANS
=========================================================== Appendix I
The Employee Retirement Income Security Act of 1974 was enacted to
protect the pension benefits of participants in most private, defined
benefit pension plans.\16 A defined benefit plan pays a retirement
benefit on the basis of a specific formula that generally takes into
account employee earnings and/or job tenure. ERISA prescribed
vesting and funding standards for defined benefit pension plans.\17
It also established a program to insure the payment of vested
benefits, up to a maximum guarantee level, for participants in
defined benefit plans that terminate with unfunded liabilities.\18
Today, the insurance program, which is administered by the Pension
Benefit Guaranty Corporation, covers about 41 million participants in
66,000 plans. As of September 30, 1993, PBGC reported a deficit (the
present value of future benefits PBGC is responsible for paying less
its assets) in its single-employer program fund of $2.9 billion.
Despite funding requirements enacted by ERISA and modified by the
Pension Protection Act, a part of the Omnibus Budget Reconciliation
Act of 1987 (OBRA 87), many defined benefit plans remain underfunded,
and the level of total underfunding has been growing. PBGC has
reported that at the end of calendar year 1992 it faced an exposure
of $53 billion in underfunded single-employer plans. Of this total,
about $14 billion was in plans sponsored by companies with
below-investment grade bond ratings and represented a risk to PBGC.
The underfunding is primarily concentrated in pension plans in the
steel, airline, tire, and automobile industries.
In previous congressional testimonies, we expressed our concern about
the large unfunded liabilities in the ongoing single-employer plans
PBGC currently insures.\19 We testified that to protect PBGC the
Congress should focus on ways to improve the funding of underfunded
plans and methods to ensure that fully funded plans remain that way.
Improving the funding in underfunded plans should benefit each of the
following parties:
plan participants, who may lose some of their pension benefits
should their underfunded plan terminate;
PBGC, which faces exposure to the risk of terminated pension plans;
sponsors of financially sound plans, who may otherwise see their
PBGC premiums increase to offset PBGC's growing losses; and
taxpayers, who may have to pay should PBGC exhaust the assets it
has for paying its obligations.
Lawmakers introduced several legislative proposals in the 102nd
Congress to improve PBGC's financial condition (S. 2014, S. 2485,
S. 3162, H.R. 3843, H.R. 4545, and H.R. 5800). Three of these
proposals involved revising the minimum funding standards for
underfunded single-employer defined benefit pension plans by
essentially requiring larger contributions from some underfunded
plans. None of these bills was enacted. Two sets of bills that
would strengthen pension funding requirements for underfunded plans
have been introduced in the 103rd Congress--the Pension Funding
Improvement Act of 1993 (H.R. 298/S. 105) and the administration's
Retirement Protection Act of 1993 (H.R. 3396/S. 1780).
--------------------
\16 ERISA also provides certain protections for participants in other
pension and welfare benefit plans.
\17 ERISA requires that plan participants, after meeting certain
requirements, be given a nonforfeitable right to the pension benefits
they have earned, even if they leave the employment of the plan
sponsor before retirement. These nonforfeitable benefits are known
as vested benefits, and the requirements, as vesting standards.
Funding standards define the minimum (and maximum) contributions the
plan sponsor must (may) make to the plan to ensure that pension
promises will be honored.
\18 Unfunded liability measures the extent that plan liabilities
exceed plan assets.
\19 See Underfunded Pension Plans: Federal Government's Growing
Exposure Indicates Need for Stronger Funding Rules
(GAO/T-HEHS-94-149, Apr. 19, 1994); Private Pensions: Most
Underfunded Plan Sponsors Are Not Making Additional Contributions
(GAO/T-HRD-93-16, Apr. 20, 1993); Assessing PBGC's Short-Run and
Long-Run Conditions (GAO/T-HRD-93-1, Feb. 2, 1993); Improving the
Financial Condition of the Pension Benefit Guaranty Corporation
(GAO/T-HRD-92-60, Sept. 25, 1992); and Financial Condition of the
Pension Benefit Guaranty Corporation (GAO/T-HRD-92-52, Aug. 11,
1992).
ERISA'S FUNDING STANDARDS
--------------------------------------------------------- Appendix I:1
Before the enactment of ERISA, only minimal pension funding rules
existed. The government imposed restrictions on pension funding
through maximum contribution limits to prevent firms from depositing
too much into tax-exempt pension trust funds. Prior law required
that contributions be sufficient to pay a plan's normal costs
(representing the cost of benefits allocated to the current year
under the plan's funding method) plus interest on unfunded past
service liabilities. This was not always sufficient to ensure that
the plan could pay all promised benefits because a reduction in
underfunding was not required. As a result, many participants lost
benefits when their pension plans terminated. ERISA was enacted to
protect the benefits of pension plan participants.
Among other provisions, ERISA established firm minimum funding rules
and created the PBGC to insure the pension benefits of participants
in defined benefit plans. These funding rules required that a plan's
minimum contribution consist of normal costs and a payment to
amortize any unamortized liabilities. From a simplified point of
view, normal costs cover benefits accruing during the plan year, and
the amortized amount is the payment to reduce plan underfunding. A
number of factors affect the amount of a plan's unamortized
liabilities--past service liabilities, experience losses and gains,
changes in plan liabilities due to actuarial assumption changes, and
contribution waivers. Under ERISA, each of these factors was
amortized over a specified period:
unfunded liabilities as of January 1, 1974, were amortized over 40
years;
unfunded liabilities of plans established after January 1, 1974,
and changes in plan liability caused by plan amendments (usually
benefit increases) were amortized over 30 years;
differences between experience and expectations based on actuarial
assumptions (that is, experience gains and losses) were
amortized over 15 years;
changes in plan liability caused by changes in actuarial
assumptions were amortized over 30 years; and
waived funding contributions were amortized over 15 years.
If a factor increases plan liabilities, an amortization charge
ensues; if it reduces liabilities, an amortization credit is given.
The net of the amortization charges and credits is the portion of the
minimum contribution that is used to reduce the plan's unamortized
liabilities.
ERISA requires each defined benefit plan to maintain a bookkeeping
account called the "Funding Standard Account" (FSA). Each year, this
account is charged with the normal costs and amortization charges for
the above factors (see fig. I.1). It is credited with amortization
credits for the above factors, any credit balance carryover from the
previous year, and cash contributions. As a general rule, a plan's
minimum funding requirement for the year is the amount by which all
charges to the account would exceed the amortization credits to the
account. The minimum funding requirement can be satisfied by the
plan's credit balance carryover, cash contributions, or a combination
of the two.
Figure I.1: The Funding
Standard Account
(See figure in printed
edition.)
The ERISA funding rules worked as intended for many plans, but by the
mid-1980s it became apparent that the funding in some plans needed
increased contributions. In the latter plans, the minimum
contribution under ERISA funding rules was not sufficient to improve
plan funding. Funding levels for some plans declined even though
sponsors were making their minimum required contributions. PBGC and
GAO found falling funding ratios (defunding) to be common among plans
that eventually terminated.\20 Defunding frequently resulted from
plan sponsors' obtaining contribution waivers from the Internal
Revenue Service (IRS), providing shutdown benefits, granting new
benefits before old benefit increases were funded, changing actuarial
assumptions, and not making contributions.
--------------------
\20 Pension Plans: Hidden Liabilities Increase Claims Against
Government Insurance Program (GAO/HRD-93-7, Dec. 30, 1992) and
Pension Plans: Government Insurance Program Threatened by Its
Growing Deficit (GAO/HRD-87-42, Mar. 19, 1987).
PPA FUNDING STANDARDS
--------------------------------------------------------- Appendix I:2
The PPA introduced certain reforms to ERISA to improve plan funding
and protect PBGC. The PPA established an additional funding
requirement for underfunded plans, instituted an additional premium
for underfunded plans (the variable rate premium), modified the
waiver process, introduced quarterly contributions, and required
notification to PBGC of missed contributions. PPA also reduced some
amortization periods and revised guidelines for using actuarial
assumptions.
The additional funding requirement\21 obligates sponsors of plans
that have an unfunded current liability to calculate an additional
contribution amount.\22 This amount can be reduced by the net of
specified amortization charges and credits the sponsor is already
making to satisfy the plan's minimum contribution requirement. We
call this net reduction amount the "offset." The FSA amortization
charges and credits not included in the offset are charges for
experience losses, credits for experience gains, and the charges and
credits arising from changes in actuarial assumptions (see fig.
I.2).
Figure I.2: Components of the
Funding Standard Account Used
in the Additional Contribution
Offset
(See figure in printed
edition.)
\a Amortization charges not used in the offset include those for the
unamortized portion of the plan's experience losses and increases in
plan liability caused by changes in actuarial assumptions.
\b Amortization credits not used in the offset include those for the
unamortized portion of the plan's experience gains and decreases in
plan liability caused by changes in actuarial assumptions.
\c Amortization charges used in the offset include those for the
unamortized portion of (1) the initial underfunding in the plan, (2)
any benefit increases granted through plan amendments, and (3) waived
funding contributions.
\d Amortization credits used in the offset include those for the
unamortized portion liability reductions made through plan
amendments.
The plan's deficit reduction contribution (DRC)--the unreduced
additional contribution requirement--is calculated by splitting the
unfunded current liability into two components--unfunded old
liability and unfunded new liability. Unfunded old liability is the
unamortized portion of the unfunded current liability at the
beginning of the plan's 1988 plan year. This unfunded old liability
is amortized over 18 years beginning with the 1989 plan year. The
unfunded new liability is the difference between the total unfunded
current liability and the sum of the unfunded old liability plus the
liability with respect to any unpredictable contingent event
benefits\23 . The payment required for the unfunded new liability
varies from 14 percent to 30 percent of the unfunded new liability,
depending on the plan's funding ratio. The better funded the plan,
the lower the required payment for its unfunded new liability.
A plan's DRC is the sum of the payments for its unfunded old
liability (the amortization payment) and its unfunded new liability.
The DRC is reduced by the offset described above. The payment for
the unpredictable contingent event benefit, if any, is added to the
adjusted DRC to determine the additional funding requirement for most
underfunded plans. The additional funding requirement can be no
larger than the underfunding in the plan at the beginning of the
plan's fiscal year.
Sponsors of underfunded plans with fewer than 101 participants
throughout the previous plan year are not required to make an
additional contribution. Sponsors of underfunded plans with 101 to
149 participants during the previous plan year need pay only 2
percent of the additional funding requirement calculated above for
each participant in excess of 100.
Special provisions apply to steel industry plans until the 1994 plan
year. These provisions limit the additional contribution that
sponsors of steel plans must make and extend the amortization period
for unpredictable contingent event benefits that arise after December
17, 1987.
--------------------
\21 This requirement is described in Sec. 302(d) of ERISA and Sec.
412(l) of the Internal Revenue Code.
\22 A plan's current liability is calculated using the plan's
actuarial assumptions except that the interest rate assumption must
be selected from a range of rates specified by the Secretary of the
Treasury. This range of rates is 90 to 110 percent of a weighted
4-year average of the 30-year U.S. Treasury bill rate ending on the
last day before the beginning of the plan year.
\23 Unpredictable contingent event benefits, commonly called
"shutdown" benefits, are found primarily in steel and automobile
industry plans and are usually paid only when all or part of a plant
or facility closes down. The payment for this liability under the
additional contribution provision is the greater of the liability
amortized over 7 years or an amount based on the yearly benefit
payments, the funding level of the plan, and a phase-in factor that
does not reach 100 percent until the year 2001. None of the plans in
our sample had unpredictable contingent event benefits in effect.
PROPOSED STANDARDS IN THE PFIA
OF 1993
--------------------------------------------------------- Appendix I:3
As a result of PBGC's growing deficit, several bills were introduced
in the 102nd Congress to increase contributions from sponsors of
underfunded plans and to improve PBGC's financial condition (S.
2014, S. 2485, S.3162, H.R. 3843, H.R. 4545, and H.R. 5800).
None was enacted. PBGC's deficit and level of exposure to
underfunded plans continued to increase, so the PFIA was introduced
in the 103rd Congress.
GENERAL PROVISIONS
------------------------------------------------------- Appendix I:3.1
The PFIA, introduced in the Congress in January 1993, aims to
increase the minimum funding requirements for underfunded plans,
change the security requirements concerning plan amendments, modify
the PBGC's reporting obligations to the Congress, and authorize the
PBGC to obtain additional information from certain plan sponsors.
MINIMUM FUNDING RULES
------------------------------------------------------- Appendix I:3.2
The PFIA proposes to improve funding for most plans with unfunded
current liabilities. Current liability is determined as under
current law, except that the allowable interest rate range is
restricted to between 90 and 100 percent of the weighted average of
the rates of interest on 30-year Treasury securities during the
4-year period ending on the last day before the beginning of the plan
year. These bills would require sponsors of such underfunded plans
to make minimum contributions equal to the highest of the
contributions required under three different funding provisions--the
ERISA requirement, the URR, and the SMR. The current additional
funding requirement would be repealed.
ERISA REQUIREMENT
------------------------------------------------------- Appendix I:3.3
The ERISA requirement is the existing funding requirement for plans
that are fully funded on a current liability basis, the 412(b)
provision under the Internal Revenue Code. This provision requires
contributions equal to the plan's normal costs plus a payment to
amortize any funding deficiency--the net of the plan's amortization
charges less amortization credits. This funding requirement is the
same as the current minimum contribution requirement under ERISA
without the existing additional funding requirement.
UNDERFUNDING REDUCTION
REQUIREMENT
------------------------------------------------------- Appendix I:3.4
The URR is the sum of (1) an amount equal to the unfunded current
liability of the plan multiplied by the applicable factor, (2) the
expected increase in the current liability attributable to benefits
accruing during the plan year, (3) the amount necessary to amortize
any waived funding deficiency, and (4) the unpredictable contingent
event benefits being paid (if any) for the plan year. The URR
contribution cannot exceed the amount necessary to increase the
beginning-of-year funding ratio to 100 percent plus the expected
increase in the current liability attributable to benefits accruing
during the plan year.
The applicable factor varies from 14 to 30 percent depending on the
funding ratio in the plan. It is the same as the factor used to
determine the payment for unfunded new liabilities under current law.
If the funding ratio is less than 35 percent, then the applicable
factor is 30 percent. The applicable factor decreases by .25 of 1
percentage point for each 1 percentage point by which the plan's
funded current liability percentage exceeds 35 percent.
SOLVENCY MAINTENANCE
REQUIREMENT
------------------------------------------------------- Appendix I:3.5
The SMR is the sum of (1) all applicable disbursements from the plan
for the plan year, (2) interest on the unfunded current liability of
the plan, (3) the expected increase in current liability attributable
to benefits accruing during the plan year, and (4) the amount
necessary to amortize any waived funding deficiency. The SMR
contribution cannot exceed the amount necessary to increase the
beginning-of-year funding ratio to 100 percent plus the expected
increase in current liability attributable to benefits accruing
during the plan year.
For purposes of this rule, "disbursements from the plan" means
benefit payments, including purchases of annuities and payment of
lump sums in satisfaction of liabilities, administrative
expenditures, or any other disbursements from the plan. In
determining the applicable amounts attributable to purchases of
annuities and the payment of lump sums, the actual purchase price or
lump-sum amount paid is multiplied by the excess of one over the
funding ratio of the plan. Thus, for example, if the funding ratio
of the plan at the beginning of the plan year is 80 percent, then the
applicable amount of annuity purchases and lump-sum payments is 20
percent of such actual disbursements.
The amount by which the proposed SMR exceeds the proposed URR is to
be phased in at 20 percent per year over 5 years. This is intended
to prevent any severe contribution increases for affected plan
sponsors in the initial years the provision is in effect.
OFFSET PROVISION
------------------------------------------------------- Appendix I:3.6
The amounts required to be contributed under either the URR or the
SMR may be reduced, at the sponsor's election, by the net of credits
to the funding standard account arising due to experience gains and
changes in actuarial assumptions, plus contributions made by the
employer to avoid an accumulated funding deficiency, minus charges to
the FSA arising due to experience losses and changes in actuarial
assumptions.
MISCELLANEOUS PROVISIONS
------------------------------------------------------- Appendix I:3.7
Plans making a benefit increase through a plan amendment would be
required to provide a security if the additional benefits increased
the plan's current liability and the plan's funding ratio, after the
amendment, was below 90 percent. The amount of the security would be
the amount over $1 million necessary to increase the plan's funding
ratio to 90 percent.
As under the current law, the rules that could increase contributions
above the ERISA requirement would not apply to plans with 100 or
fewer participants and would apply only partially for plans with 101
to 149 participants.
PROPOSED STANDARDS IN THE RPA
OF 1993
--------------------------------------------------------- Appendix I:4
Title I of the RPA (H.R. 3396/S. 1780), first introduced in the
103rd Congress on October 28, 1993, makes several changes to the
ERISA funding rules to strengthen the minimum funding requirements
for underfunded plans. Among the provisions of titles II, III, and
IV are proposals to make changes in reportable events and in the
information required to be furnished to plan participants and PBGC,
give authority to PBGC to bring civil actions to enforce minimum
funding standards, and phase out the cap on the variable rate
premium.
MINIMUM FUNDING RULES
------------------------------------------------------- Appendix I:4.1
The RPA provisions would strengthen the minimum funding rules in two
ways. First, certain provisions restricting allowable actuarial
assumptions could increase a plan's current liability. This will
subject more plans to the additional contribution requirement and
increase the amount of additional contributions some sponsors will
pay. Second, other provisions would add a solvency test for
underfunded plans and make other changes that would increase the DRCs
for some sponsors.
PROVISIONS AFFECTING PLAN
LIABILITIES
------------------------------------------------------- Appendix I:4.2
The bill would restrict the actuarial assumptions that plans could
use when calculating current liabilities. Like the PFIA, the RPA
would restrict interest rates to the lower half of the current
liability interest rate range. It would also require plans to use
uniform mortality assumptions. Each restriction will increase
current liabilities for some plans. Liabilities can also increase
because of a proposed requirement that employers immediately
recognize any benefit increases negotiated under a collective
bargaining agreement. Under current law, employers are permitted,
but not required, to recognize these increases immediately.
PROVISIONS AFFECTING
ADDITIONAL CONTRIBUTIONS
------------------------------------------------------- Appendix I:4.3
The bill would change the DRC by changing the formula for the
unfunded new liability amount and by adding the expected increase in
current liability due to benefits accruing during the plan year. The
unfunded new liability amount formula would extend the 30-percent
amount to plans with funding ratios of 60 percent and lower. For
plans that are more than 60-percent funded, the applicable DRC
percentage would decrease gradually to 20 percent as the plans became
100-percent funded.
The bill would modify the offset to the DRC. The offset would equal
the plan's normal cost plus all amortization charges less all
amortization credits.
The bill provides a transition rule to limit increases in additional
contributions. Under this rule, the increase in a plan's additional
contribution would be limited to the amount necessary to increase the
plan's funding ratio by a specified percentage that depends on the
initial funding ratio of the plan and the particular plan year or the
additional contribution that would be required under current law,
whichever is greater. The transition rules would be in effect for
the 1995 through 2001 plan years.
The bill also proposes a new solvency rule that would require
underfunded plans to maintain liquid assets equal to 3 years' worth
of benefit payments and other disbursements. The determination would
be made on a quarterly basis. If a plan's liquid assets fell below
this amount, the employer would be obligated to contribute enough to
the plan to raise assets to the required level.
SELECTION OF GAO'S SAMPLE OF
UNDERFUNDED PENSION PLANS AND
DESCRIPTION OF OUR ANALYSES
========================================================== Appendix II
This appendix describes the process we used to select our sample of
93 underfunded pension plans. It also describes the analyses we
performed to determine (1) how well the current funding provisions
are working (see app. III), (2) the likely effects of funding
provisions proposed in the Pension Funding Improvement Act of 1993
(H.R. 298/S. 105) (see app. IV), and (3) the likely effects of the
proposed standards in title I of the Retirement Protection Act of
1993 (H.R. 3396/S. 1780) (see app. V). We did our work between
January 1992 and April 1994 in accordance with generally accepted
government auditing standards.
DATA SELECTION
-------------------------------------------------------- Appendix II:1
We used a database of plans paying the variable rate premium that the
Pension Benefit Guaranty Corporation provided to define our
population of underfunded plans and selected a random sample for our
analyses. We used information from the Form 5500 (Annual
Return/Report of Employee Benefit Plan) data for this sample of plans
to (1) identify plans receiving additional contributions, (2) analyze
factors that affected the amounts of these additional contributions,
and (3) estimate the effects of current pension plan funding
proposals.
The Pension Protection Act, a part of the Omnibus Budget
Reconciliation Act of 1987, defines pension plan underfunding for
variable rate premium purposes differently from underfunding for
additional contribution purposes. The differences arise primarily
because the interest rates that plans are allowed to use for the two
purposes differ. The interest rate used to calculate plan
liabilities for the variable rate premium has been lower than the
range of allowable rates that plans must use to calculate their
current liabilities since the two rates became effective.\24 This
increases the liabilities for the variable rate premium relative to
those for additional contributions. As a result, to date all plan
sponsors required to make additional contributions to reduce their
plan's underfunding should have paid the variable rate premium.
Thus, we used the OBRA 87 definition of pension plan underfunding and
selected these plans from PBGC's list of sponsors who pay the
variable rate premium as the universe of plans for our analysis.
PBGC provided us a data tape of plan information for all plans that
paid the variable rate premium in 1990, the most recent year for
which relatively complete premium payment data were available. We
did not verify the accuracy of these data though we found they
contained several inconsistencies.
The PBGC premium payment data tape contained 15,472 plans whose
sponsors paid the variable rate premium in plan year 1990. Of these
plans, 10,203 plans, or about 66 percent, had fewer than 101
participants and were thus exempt from making additional plan
contributions. We randomly selected a sample of 105 plans that could
be subject to the additional contribution requirement from the
remaining 5,269 plans.
Because the additional contribution requirement became effective with
plan years beginning in January 1, 1989, we collected Form 5500 and
related Schedule B (Actuarial Information) data for plan years 1987
through 1990. However, our analysis focused on the 1990 plan year.
No one agency had all Form 5500s for all the plans in our sample, so
we contacted the Department of Labor, the Internal Revenue Service,
and/or individual pension plan administrators to obtain these forms.
We eliminated 12 plans from our sample of 105. We could not obtain
sufficient plan data for six of these plans. The remaining six plans
were misidentified on the PBGC data tape and should not have been
included in our universe because three were multiemployer plans, two
were defined contribution plans, and one had fewer than 101
participants.\25 This left us with a final sample of 93 plans on
which we performed our analyses.
The sampling error of the estimates made from the final sample of 93
plans is no greater than plus or minus 11 percentage points at the
95-percent confidence level. That is, the chances are 19 out of 20
that the actual number of plans or percentage of plans being
estimated falls within plus or minus 11 percentage points of our
estimate. For certain parts of our analysis, we analyze data
pertaining to subsets of our 93 plan sample; for example, the 57
plans with unfunded current liabilities. In these cases, the
sampling error will be larger than that for the full sample of 93
plans.
To account for the six plans that we identified from our sample that
should not have been included in our universe, we adjusted the
universe to which our analysis applied to 4,968 plans. We did this
by reducing our sample size by the six that should not have been
included (105-6), dividing the result by the original sample size
(99/105), and multiplying our original universe (5,269) by that
ratio. Therefore, the 93 sample plans represent an adjusted universe
of 4,968 plans. We implicitly assumed that the six defined benefit
plans for which we could not obtain sufficient data have similar
characteristics to the 93 plans included in our final sample.
We reviewed summary plan descriptions to identify plans by benefit
type, such as flat benefit plans or salary-based plans. We use the
term "flat benefit plans" to identify plans whose monthly benefits
are determined by multiplying years of service by a specified dollar
amount (for example, years of service times $20). Of our sample of
93 plans, 45, almost half, were flat benefit plans. The remaining 48
plans consisted of 28 salary-based plans, 14 combination salary/flat
benefit plans (usually salary-based plans with a flat benefit-based
minimum benefit), and 6 other types of plans. For our analysis, we
considered the pure flat benefit plans as one group and combined all
other plans into a second group identified as nonflat benefit plans.
--------------------
\24 The interest rate plans must use for the variable rate premium is
80 percent of the 30-year Treasury bill rate on the day before the
beginning of the plan year. The range of allowable rates is 90 to
110 percent of a weighted 4-year average of the 30-year Treasury bill
rate. If long-term interest rates are steady or falling, as they
have been in the past few years, then the interest rate for the
variable rate premium liabilities will be lower than the allowable
range of rates used to calculate current liabilities. Should
long-term interest rates rise, the interest rate used to calculate
the variable rate premium liabilities could fall within, or exceed,
the allowable range used to calculate current liabilities.
\25 Sponsors report the number of plan participants on two forms--the
form used to calculate the variable rate premium and the form to
calculate additional contributions. This plan sponsor reported over
101 participants on the form submitted for determining the variable
rate premium. Therefore, we initially included this plan in the
universe of 5,269 plans. However, it reported fewer than 101
participants on the form for determining additional contributions.
As a result, we eliminated this plan from our final universe.
DATA ANALYSES
-------------------------------------------------------- Appendix II:2
We used the sample of 93 plans to determine what portion of sponsors
were making additional contributions to reduce the underfunding in
their plans. For the plans not receiving additional contributions,
we determined what portion was not underfunded on a current liability
basis, what portion had sufficient offsets to eliminate any required
additional contribution, what portion miscalculated the size of the
required additional contribution, and what portion did not make the
additional contribution calculation. We contacted the plan
administrators for all plans in this last group to determine why the
calculations were not made. We did not determine if the
contributions aside from the additional contributions were correctly
calculated.
SENSITIVITY ANALYSIS OF PPA
REQUIREMENTS
------------------------------------------------------ Appendix II:2.1
We performed a sensitivity analysis to assess the impact of various
components of the PPA requirements--the current funding
provisions--on plan sponsors making additional contributions and the
size of those contributions. These components can affect the size of
the resulting additional contribution. In our sensitivity analysis,
we assessed the impact of three of these components--offsets,
amortization of old and new plan underfunding over different time
periods, and interest rates used to calculate the current
liability--on the size of additional contributions for the 93 plans
in our sample. We identified the impact of each of these components
on flat and nonflat benefit plans in the above sample.
ANALYSIS OF PROPOSED FUNDING
RULES CHANGES IN THE PFIA
------------------------------------------------------ Appendix II:2.2
Next, we used our sample of 93 plans to identify the impact of
proposed changes in pension plan funding rules contained in PFIA.
Among other provisions, these bills would restrict the allowable
interest rate range that could be used to determine plan liabilities.
We calculated the effect this restricted range would have on the
underfunded status of the plans in our sample. We also calculated
the amount of additional contributions that the plans with unfunded
current liabilities would make under the three alternative
contribution rules contained in the bills.
PFIA provides a 5-year phase-in period for the SMR alternative to
ease its impact on plan sponsors. Because we are interested in the
ultimate impact of these bills, we only briefly report anticipated
effects during the phase-in period and, instead, concentrate on the
anticipated effects once the phase-in is complete.
We determined the probable effects of PFIA on mature rather than
young pension plans. We defined a mature plan as one having 40
percent or more of its liabilities attributable to retirees. We did
this analysis to address our concern that the bills in their current
form would be more burdensome on mature plans than on young plans.
Additionally, we compared the probable effects of PFIA on flat
benefit plans as opposed to nonflat benefit plans.
We then analyzed PFIA's section 102(d)--the transition use of credit
balances (offsets that affect two of the contribution
alternatives)--to determine how large an impact this provision would
have on reducing the increase in contributions that these bills would
otherwise provide.
ANALYSIS OF PROPOSED
STANDARDS IN THE RPA
------------------------------------------------------ Appendix II:2.3
Finally, we performed an analysis of the proposed standards in title
I of the RPA--H.R. 3396/S. 1780. RPA would make several changes to
the ERISA funding rules to strengthen the minimum funding
requirements for underfunded plans.
We estimated how the current liability of the 93 plans in our sample
would change because of the proposed restrictions on the mortality
and interest rates. We calculated how many sponsors of these plans
would subsequently be subject to the modified additional contribution
provisions and how many would be required to make additional
contributions. We then estimated the size of these additional
contributions after accounting for the proposed changes in the rules
for calculating the DRC, offset, and the transitional limitation that
would be in effect through the 2001 plan year. We also determined
the effects of the proposed solvency rule in RPA that would require
underfunded plans to maintain liquid assets equal to 3 years' worth
of benefit payments and other disbursements. Finally, we performed a
sensitivity analysis to determine how each of several modifications
to the RPA provisions would affect the number of sponsors making
additional contributions and the size of those contributions.
We did not have sufficient data to estimate the effects on plan
funding of either the proposal that sponsors immediately recognize
all negotiated benefit increases or the proposal that some sponsors
be exempt from IRS excise taxes for certain nondeductible
contributions.
ANALYSIS OF THE CURRENT ADDITIONAL
CONTRIBUTION PROVISION
========================================================= Appendix III
This appendix describes how well current funding rules are working to
reduce unfunded current liabilities in single-employer defined
benefit plans. We determined what portion of sponsors of underfunded
plans are making additional contributions and the reasons why some
sponsors do not make additional contributions. We also performed a
sensitivity analysis to identify which characteristics of the current
funding rules have the greatest impact on the number of sponsors
making additional contributions and on the amount of their additional
contributions.
DESCRIPTION OF THE PROVISION
------------------------------------------------------- Appendix III:1
The additional contribution provision requires sponsors of defined
benefit pension plans with unfunded current liabilities to determine
if they need to make additional contributions to reduce underfunding
in their plan.\26 Unfunded liabilities are separable into three
components--liability arising with respect to unpredictable events,
the residue of the total underfunding extant at the start of the 1988
plan year (the unfunded old liability), and the balance after
accounting for the first two components (the unfunded new liability).
The first step in determining a plan's additional contribution is to
calculate the deficit reduction contribution. The DRC is the sum of
the amount needed to amortize the unfunded old liability over 18
years (beginning in 1989) and the payment for the unfunded new
liability, which depends on the total funding level of the plan. The
second step is to reduce the DRC by subtracting amortization payments
the sponsor is making for liabilities arising from original plan
benefits, subsequent benefit improvements, and any past contributions
deferred by Internal Revenue Service waivers. We call these payments
"offsets." Finally, the remainder is increased by a payment for any
unpredictable events liability. This sum, limited to the
underfunding in the plan at the beginning of the plan year, is the
required additional contribution for plans with 150 or more
participants. Plans with 101 to 149 participants receive a reduced
additional contribution, and plans with 100 or fewer participants the
previous year are not subject to the additional contribution
provision.
--------------------
\26 See appendix I for a detailed discussion of the specifics of this
provision.
MOST UNDERFUNDED PLANS DO NOT
RECEIVE ADDITIONAL
CONTRIBUTIONS
------------------------------------------------------- Appendix III:2
The additional contribution provision lacks efficacy because sponsors
of most underfunded plans are not required to make additional
contributions. In 1990, more than 15,000 defined benefit plans paid
the Pension Benefit Guaranty Corporation's variable rate premium
because they were underfunded. Sponsors of about two-thirds of these
plans were exempt from making additional contributions because they
had 100 or fewer participants in the plans throughout the 1989 plan
year. We drew a random sample of 93 plans from the remaining 4,968
"large" plans to determine how many sponsors were making additional
contributions. We also identified the reasons some sponsors were not
making additional contributions to their underfunded plans.
Sponsors of less than 25 percent of the 93 plans were making
additional contributions to their plans. Fig. III.1 shows the
distribution of these plans by additional contribution status. Of
the 93 plans,
33 were not underfunded on a current liability basis,
22 were underfunded on a current liability basis and receiving
additional contributions from the plan sponsor,
32 were underfunded on a current liability basis but had sufficient
offsets to nullify any required additional contributions, and
6 were underfunded on a current liability basis but did not
determine if they owed additional contributions.\27
In addition, three of these last six plans were exempt from making
the determination, but the other three should have made the
determination; one of these, we calculate, should have received
additional contributions.
Figure III.1: Distribution of
93 Plans Paying PBGC's Variable
Rate Premium, by Additional
Contributions Payment Status,
1990
(See figure in printed
edition.)
Source: 1990 IRS Form 5500, Schedule Bs of the 93 plans.
Percents do not sum to 100 due to rounding.
Of the 93 plans in our sample, 57 were underfunded and subject to the
additional contribution provision. Twenty-three plans, only 25
percent of our sample or 40 percent of the plans subject to the
provision, made, or should have made, additional contributions.
Twenty-two sponsors paid $2.8 million in additional contributions.
These additional contributions increased the total 1990 minimum
contributions for the 22 sponsors by 26 percent but erased only 2.6
percent of their plans' underfunding.
--------------------
\27 In our testimony before the Subcommittee on Oversight, House
Committee on Ways and Means (Private Pensions: Most Underfunded Plan
Sponsors Are Not Making Additional Contributions GAO/T-HRD-93-16,
Apr. 20, 1993), we reported that 11 underfunded plans had not
determined if they should have made additional contributions. The
data we received from the Department of Labor for five of these plans
were abridged and did not contain the additional contribution
determinations reported by the plans. The sponsor of one plan made
additional contributions, but the other four plans had sufficient
offsets so that additional contributions were not required. The
remaining six plans are those discussed above.
PROJECTIONS TO THE
POPULATION
----------------------------------------------------- Appendix III:2.1
Our sample size indicates with 95-percent confidence that between
2,522 and 3,568 of the 4,968 large plans paying PBGC variable rate
premiums are subject to the additional contribution provision. We
estimate that sponsors of between 715 and 1,635 of these plans
actually made additional contributions in 1990. Looked at another
way, only 5 to 11 percent of the more than 15,000 plans paying the
PBGC variable rate premium were also receiving additional
contributions to improve their funding.
PLANS WITH NO CURRENT
LIABILITY UNDERFUNDING
----------------------------------------------------- Appendix III:2.2
A plan may have an unfunded liability for the variable rate premium
and be fully funded for purposes of the additional contribution.
This occurs because in 1990 plans were required to use an interest
rate to calculate their liabilities for PBGC's premium payment
purposes that was lower than any rate in the range of allowable rates
that had to be used to calculate current liabilities. The lower the
interest rate used to calculate plan liabilities, other things equal,
the higher will be the resulting liability.
To demonstrate the effects of interest rates on plan liabilities,
assume that the plan has promised to pay a participant $100 one year
from now. How much money does it need to have now to pay the $100
next year (assuming no additional sponsor contributions)? It depends
on the interest rate. If the interest rate is 5 percent, the plan
needs $95.24 today to pay the $100 next year ($95.24 times 1.05 =
$100). This $95.24 is the plan's current liability when the interest
rate is 5 percent. However, if the interest rate is 10 percent, it
needs only $90.91 today to pay $100 next year. The interest rate
increased and today's liability decreased.
The interest rate plans are required to use when calculating their
liability for PBGC premium purposes is 80 percent of the 30-year U.S.
Treasury bill rate for the month before the beginning of the plan's
fiscal year. This rate has been below the range of rates from which
plans select when calculating their current liabilities since the two
interest rate measures became effective in January 1988 (see fig.
III.2). We discuss interest rates further in the sensitivity
analysis below.
Figure III.2: Interest Rates
for Determining the Variable
Rate Premium Liabilities and
the Range of Allowable Rates
for Determining Current
Liabilities, January 1989 -
January 1993
(See figure in printed
edition.)
OFFSETS
----------------------------------------------------- Appendix III:2.3
Offsets allow sponsors subject to the additional contribution
provision to reduce or eliminate such contributions. The offsets
eliminated the additional contribution for 32 of the 57 plans in our
sample that had unfunded current liabilities and would have
eliminated them for two plans that did not make the calculation. The
offsets were sufficient to eliminate the $16.3 million DRC from these
34 plans. In addition, 16 of the 22 plan sponsors making additional
contributions in 1990 claimed offsets of $13.0 million. These 16
sponsors made only $2.6 million in additional contributions.
PLANS THAT DID NOT DETERMINE
THEIR ADDITIONAL
CONTRIBUTION REQUIREMENTS
----------------------------------------------------- Appendix III:2.4
Six plans that were underfunded on a current liability basis did not
calculate their additional contributions. Three of these plans were
exempt from making the determination--one was a contributory plan
whose employee contributions were not included in the funding
standard account assets measure (the plan was fully funded counting
these contributions), one was a new plan whose sponsor was exempt
from making additional contributions for the first plan year (and
will be required to make only partial additional contributions for
the next 4 years), and one had fewer than 101 participants on each
day of the 1989 plan year even though it reported more than 100 for
the 1990 plan year.\28
The remaining three plans should have made the additional
contribution determination but probably did not do so because the
instructions were unclear. The instructions for the Form 5500,
Schedule B item 13, state that "Multiemployer plans or plans with NO
unfunded current liability or plans with 100 or fewer participants"
need not make the additional contribution determination. For each of
these three plans, the market value of assets (reported on line 6c of
the Form 5500 Schedule B) exceeded the plan's current liability (line
6d). Thus, the plans appear fully funded by this comparison.
However, the funding standard account asset level (line 8b) less the
prior year's credit balance (line 9h), the correct asset value to use
for this purpose, did not exceed the plans' current liabilities. If
the person preparing the Schedule B did not read beyond the quoted
portion of the instructions, he or she might not have realized that
the market value of assets is not the correct asset measure to use
when determining whether the plan is fully funded on a current
liability basis.
The sponsors of two of these three plans had sufficient offsets to
negate the DRC. The third, we estimate, should have made a small
additional contribution of less than $8,500.
--------------------
\28 In our opinion, basing the additional contributions due this year
on the maximum number of participants in the plan last year is unwise
from an enforcement standpoint. First, plans do not report the
maximum number of participants in the plan during the year. Second,
the compliance auditor should not be required to find the previous
year's Form 5500 filing to determine if the underfunded plan had
fewer than 101 participants that year and, thus, might be exempt from
the additional contribution requirement.
FLAT VERSUS NONFLAT BENEFIT
PLANS
----------------------------------------------------- Appendix III:2.5
Forty-five of the 93 plans in our sample were so-called flat benefit
plans.\29 Of the other 48 plans, 28 were salary-based plans, 14 were
a combination of flat benefit and salary-based plans--most were
salary-based plans with a flat benefit minimum benefit, and 6 plans
were other types of plans. For this analysis, we grouped the pure
flat benefit plans together and put all other plans into the second,
nonflat benefit group.
Table III.1 shows that flat benefit plans are more likely than other
plans in our sample to be underfunded on a current liability basis
(76 percent versus 48 percent), but less likely to be receiving
additional contributions from their sponsors. Only one-quarter of
the flat benefit plans with unfunded current liabilities were
receiving additional contributions compared with over half the
nonflat benefit plans.
Table III.1
Underfunded Plans Making Additional
Contributions, by Plan Type
Flat Nonflat
benefit benefit
All plans plans plans
------------------------ ---------- ---------- ----------
Total number 93 45 48
Number of plans with 57 34 23
unfunded current
liabilities
Total amount of $201,550,0 $128,335,0 $73,216,00
underfunding 00 00 0
Number of plans 22 9 13
receiving additional
contributions
Total amount of $2,809,000 $1,327,000 $1,482,000
additional
contributions
------------------------------------------------------------
The additional contributions had a larger impact on the funding of
nonflat benefit plans. The additional contributions were equivalent
to 2.6 percent of the underfunding in plans that received them--11
percent in nonflat benefit plans but only about 1.5 percent in the
flat benefit plans. This difference is caused in large part by the
greater offsets available to flat benefit plans. These offsets
arise, in part, because flat benefit plans regularly give benefit
increases through plan amendments, and the amortization payments for
these benefit increases are used to offset any additional
contribution requirement.
--------------------
\29 In these plans, monthly benefits are determined by multiplying
years of service by a specified dollar amount (for example, years of
service times $20).
SENSITIVITY ANALYSIS
------------------------------------------------------- Appendix III:3
Several components of the additional contribution determination
process can affect the size of the resulting additional contribution
requirements. In this sensitivity analysis, we examined three of
these components--interest rates used to calculate current liability,
separation of plan underfunding into old and new components, and the
offsets--to estimate the relative effects for the 93 plans in our
sample.
INTEREST RATES
----------------------------------------------------- Appendix III:3.1
Using higher interest rates reduces a plan's calculated liabilities,
other things equal. To calculate its current liability, a plan can
select any interest rate from the allowable range of rates. The
range can change monthly to reflect changes in the 30-year U.S.
Treasury bill rate. During 1990, the range was relatively stable
with the midpoint of the range only varying from 8.55 percent to 8.63
percent.
If plan sponsors were trying to avoid the additional contribution, we
would expect to see a large portion of the plans, especially plans
with unfunded current liabilities, using an interest rate near the
top of the range. To test this, we divided the monthly interest rate
ranges for our plans into five groups--we divided the range into
thirds and added groups for the top and bottom of the range. Table
III.2 shows that few plans used high interest rates to calculate
their liabilities. Less than 25 percent of the plans in our sample
used an interest rate in the top third of the allowable range, and
only two plans used the highest interest rate allowable. Flat
benefit plans in our sample were more likely than nonflat plans to
use an interest rate in the top third (29 percent versus 17 percent).
Table III.2
Interest Rates Used to Calculate Current
Liabilities for 93 Plans, by Plan Type
and Funding Level
Full Full
All y y
plan fund Underfunde fund Underfunde
Interest rate s ed d ed d
------------------ ---- ---- ---------- ---- ----------
Top of range 2 1 0 1 0
Top one-third 19 3 9 4 3
Middle one-third 30 4 11 6 9
Bottom one-third 37 3 14 13 7
Bottom of range 5 0 0 1 4
Total 93 11 34 25 23
------------------------------------------------------------
The implication of the relative lack of use of the highest allowable
interest rates is that a slight restriction of the allowable range is
not likely to have a great impact on increasing additional
contributions. Legislation has been introduced (S. 105/H.R. 298
and S. 1780/H.R. 3396) that would limit the allowable range for
calculating current liabilities to the bottom half of the current
range.\30 We calculated that such a halving of the allowable range
would have made only two additional plans underfunded on a current
liability basis (one flat benefit plan and one nonflat benefit plan)
and that total plan underfunding would have increased by only 7
percent (see table III.3). Such a change would not cause any
additional plan sponsors in our sample to make additional
contributions,\31 but total additional contributions would increase
by 20 percent from $2.8 million to $3.4 million.
Table III.3
Effects of Alternative Interest Rate
Ranges on Plan Underfunding and
Additional Contributions, by Plan Type
Nonfla
Flat t
benefi benefi
All t t
Effective interest rate range plans plans plans
------------------------------------ ------ ------ ------
Total number 93 45 48
Number of plans with unfunded current liabilities
------------------------------------------------------------
Current law 57 34 23
S. 105/H.R. 298 59 35 24
Bottom of range 69 41 28
Number of plans receiving additional contributions
------------------------------------------------------------
Current law 22 9 13
S. 105/H.R. 298 23 10 13
Bottom of range 36 19 17
Amount of additional contributions
------------------------------------------------------------
Current law $2,809 $1,327 $1,482
,000 ,000 ,000
S. 105/H.R. 298 3,364, 1,869, 1,495,
000 000 000
Bottom of range 8,398, 5,869, 2,529,
000 000 000
------------------------------------------------------------
The estimated increase in additional contributions when using the
range of interest rates specified in S. 105/H.R. 298 comes from the
plans whose current liabilities increased as the result of using a
lower interest rate. The higher liabilities increased the plans'
underfunding, which lowered their funding ratios. For most plans,
all the additional underfunding would be unfunded new liability.\32
The combination of a lower funding ratio, increase in unfunded new
liability, and no additional offsets is responsible for the large
percentage increase in the additional contributions for all plans.
We also estimated the impact on additional contributions of requiring
plans to use the interest rate at the bottom of the allowable range
of rates. This alternative would increase current liabilities for
the 88 plans that selected interest rates above the bottom of the
range. Sixty-nine of the 93 plans would be underfunded on a current
liability basis, and more than half of these (36) would be receiving
additional contributions from their sponsors. The number of flat
benefit plans receiving additional contributions would more than
double to 19 plans, and the total additional contributions to these
plans would increase by almost 350 percent to $5.9 million. In
contrast, the number of nonflat benefit plans making additional
contributions would increase by less than one-third to 17 plans, and
total additional contributions would not quite double to $2.5 million
(see table III.3).
Reducing interest rates used to calculate current liabilities is one
way to increase additional contributions. However, to have a major
impact, some rather severe reductions in the allowable range will be
necessary.\33
--------------------
\30 The current allowable range is 90 to 110 percent of the 4-year
weighted average of the 30-year U.S. Treasury bill rate. The
proposals would reduce the allowable range to 90 to 100 percent of
this weighted average rate.
\31 The additional plan shown in table III.3 that would receive
additional contributions is the plan that we determined should have
received additional contributions under current law.
\32 For 21 plans in our sample, the unfunded old liability was
greater than the plan's unfunded current liability. The unfunded new
liability for these plans was $0 when using their selected interest
rate and will increase only to the extent that the increased unfunded
current liability exceeds the unfunded old liability.
\33 Falling interest rates over the past 3 years and the "stickiness"
of actuarial assumptions suggests that in 1994 a greater portion of
underfunded plans will be using an interest rate in the top half of
the allowable range. Therefore, we would expect a larger impact
today from restricting the interest range than we estimate would have
occurred in 1990.
ELIMINATING UNFUNDED OLD
LIABILITY
----------------------------------------------------- Appendix III:3.2
A plan's unfunded current liabilities can be divided into three
components under current law--unpredictable contingent event
benefits, unamortized unfunded old liability, and unfunded new
liability. The unfunded old liability amount is amortized over 18
years (beginning with the 1989 plan year) while the unfunded new
liability is amortized over a substantially shorter period that
depends on the plan's funding ratio.
We estimated the impact on our 93 sample plans of amortizing the
remaining unfunded old liability over the shorter unfunded new
liability period. This change does not affect the number of plans
that are underfunded on a current liability basis nor does it affect
the total underfunding in these underfunded plans. It does affect
the size of the DRC before applying any offsets.\34 This change
increases the DRC by amortizing the unfunded old liability over a
period shorter than 18 years. Sponsors of plans that had an unfunded
old liability and who were making additional contributions under
current law would make increased additional contributions. Some
sponsors that had offsets sufficient to negate the DRC under current
law would have to pay additional contributions if unfunded old
liability is treated like unfunded new liability.
Treating unfunded old liability like unfunded new liability has a
substantial impact on the number of plans receiving additional
contributions and the total amount of these contributions, especially
for flat benefit plans. The number of plans in our sample that would
receive additional contributions would increase from 22 to 32, and
the total additional contributions would almost quadruple to $10.1
million (see table III.4).
Table III.4
Effects of Alternative Treatment of
Unfunded Old Liabilities, Offsets, and
Allowable Interest Rates on Plan
Underfunding and Additional
Contributions, by Plan Type
Flat Nonflat
benefit benefit
All plans plans plans
------------------------ ---------- ---------- ----------
Total number 93 45 48
Number of plans with unfunded current liabilities
------------------------------------------------------------
Current law 57 34 23
Bottom of range 69 41 28
Number of plans receiving additional contributions
------------------------------------------------------------
Current law 22 9 13
No old underfunding 32 18 14
No offsets 57 34 23
Modified offsets 32 20 12
Offsets limited to 50 57 34 23
percent of DRC
Modified offsets and no 37 25 12
old underfunding
Bottom of range, 50 34 16
modified offsets, and
no old underfunding
Amount of additional contributions
------------------------------------------------------------
Current law $2,809,000 $1,327,000 $1,482,000
No old underfunding 10,084,000 7,402,000 2,682,000
No offsets 34,438,000 18,327,000 16,112,000
Modified offsets 19,875,000 10,203,000 9,672,000
Offsets limited to 50 23,455,000 12,151,000 11,304,000
percent of DRC
Modified offsets and no 26,893,000 18,306,000 8,587,000
old underfunding
Bottom of range, 50,054,000 31,530,000 18,523,000
modified offsets, and
no old underfunding
------------------------------------------------------------
Note: Dollar amounts may not sum to "All plans" total due to
rounding.
--------------------
\34 As time passes, the unfunded old liability will diminish (and be
eliminated after 2006) and a greater portion of a plan's total
unfunded liability will be from unfunded new liability. If total
plan underfunding remains constant or increases, the DRC and
additional contributions will increase.
OFFSETS
----------------------------------------------------- Appendix III:3.3
Offsets were allowed against the DRC because plan sponsors already
amortize the costs associated with the plan's underfunding in the
FSA.\35 The underfunding reduction contribution in the FSA is total
amortization charges less the total amortization credits. However,
for most plans, the offsets include most, but not all, amortization
charges and ignore most amortization credits. Thus, the offsets used
to adjust the additional contribution for most plans are larger,
often much larger, than the payments the sponsor is actually making
to the FSA to reduce its plan's underfunding. This explains why
offsets are sufficient to nullify the DRC for 34 of the 57
underfunded plans in our sample.
As an example, one plan in our sample was underfunded by $1.7 million
and its preoffset DRC was about $230,000. The $660,000 in offsets
for this plan was based on an outstanding cost balance of $7.2
million.\36 The plan's underfunding is substantially less than the
cost basis for the offsets because the balance on which the plan's
amortization credits is based ($7.2 million) is not taken into
account. The $675,000 in amortization credits reduced the net
amortization payment to the plan's FSA to $225,000. This is $5,000
less than the preoffset DRC, yet no additional contributions were
made because the amortization credits were not used to reduce the
offset.
Offsets also reduced the additional contributions of 16 of the 22
plans making them. If there were no offsets, all 57 plans that had
unfunded current liabilities would have received additional
contributions. We estimated that without the offsets the aggregate
additional contributions for the 57 plans would have been $34.4
million, more than 12 times the additional contributions actually
received (see table III.4). The minimum contribution for these 57
plans was $33.2 million, not counting current law additional
contributions, so eliminating the offset would more than double plan
contributions, on average.
In our opinion, the design of the current law offset is flawed. Our
concern is that plan sponsors can use amortization charges to reduce
or eliminate their additional contributions and then use amortization
credits to reduce those same charges in the FSA. The current
procedures result in a double reduction of the sponsor's
contributions that are designed to decrease plan underfunding. If
the design flaw, which we believe is the unanticipated and unintended
consequence of the offset's last-minute insertion into the PPA, is
not corrected, offsets will continue to reduce required additional
contributions.
As long as a plan is underfunded, its sponsor should make a specific
contribution to reduce the underfunding that is, at a minimum, no
less than the DRC. If sponsors are allowed to use offsets that
eliminate the DRC and, as a result, total underfunding reduction
contributions are less than the DRC (as can be the case under current
law), then plan underfunding may continue.
We believe that the difference between the total amortization charges
and the total amortization credits is a more appropriate offset
measure. This is the amount the sponsor is actually contributing to
reduce plan underfunding under the old ERISA funding rules. Using
this offset measure would ensure that the DRC would be the minimum
underfunding reduction contribution.
This modified offset would not allow a double reduction in
contributions, and contributions for sponsors of many underfunded
plans would consequently increase. In our sample, using the modified
offset would increase the number of plan sponsors making additional
contributions from 22 to 32. The number of sponsors of flat benefit
plans making additional contributions would more than double to 20.
Total additional contributions for all plans would increase from $2.8
million to $19.9 million.
This large increase in additional contributions indicates that the
amortization credits currently excluded from the additional
contribution calculations, but used to reduce sponsor contributions
in the FSA, are far greater than the amortization charges that are
not currently used to offset the DRC.
The modified offset is not sufficient to ensure that all sponsors of
underfunded plans make additional contributions to improve plan
funding. To achieve such assurances, the offsets must be either
eliminated or restricted so that they cannot eliminate the entire
DRC.
One way to ensure that all sponsors of underfunded plans make at
least some additional contributions would be to limit the offset to a
specified percentage of the DRC. For example, we estimated the
impact of limiting the modified offset to be no greater than 50
percent of each plan's DRC. At a minimum, all sponsors of
underfunded plans would make an additional contribution equal to 50
percent of the DRC. If such a restriction were in effect, the 57
sponsors in our sample would make additional contributions of $23.5
million.
Because pension contributions are a tax deductible expense, any
increase in contributions will result in a decrease in federal
revenues, which will cause the pay-as-you-go restrictions to
apply.\37 The revenue loss from the new additional contributions will
have to be offset by other revenues or by expenditure reductions.
--------------------
\35 The offset does not appear in the proposed PPA legislation but
was added during the conference agreement. Amortizing underfunding
over 18 or fewer years in the DRC would result in a larger payment
than amortizing it over the amortization periods used in the FSA,
those who designed the offset believed. (The 30-year amortization
period for benefit increases was thought to be the main cause for
poor plan funding.) Those designing the offset did not want plan
sponsors to make two amortization payments per year for the same
underfunding, so they allowed the DRC payment to be reduced by the
FSA charges (and increased by the FSA credits) that were amortized
over 30 years or longer.
\36 The plan had an additional cost balance of $1.6 million, but the
$240,000 amortization payments for these additional costs are not
used to offset the plan's DRC.
\37 Under the Budget Enforcement Act, PAYGO requires that all direct
spending and tax legislation enacted during a session of the Congress
must be deficit neutral in the aggregate.
COMBINING CHANGES
----------------------------------------------------- Appendix III:3.4
If two or all three of these components were changed as above, the
impact would be greater than if only one were changed. For example,
by treating unfunded old liability like unfunded new liability and
making the offset equal to all amortization charges minus all
amortization credits, we estimate that 37 of the 57 sponsors of
underfunded plans would be making $26.9 million in additional
contributions (see table III.4). Compare this with the 22 plan
sponsors making $2.8 million in additional contributions under
current law. If the sponsors were also required to use the interest
rate at the bottom of the allowable range, the number of underfunded
plans would increase to 69, and sponsors of 50 would be making a
total of over $50 million in additional contributions.
CONCLUSIONS
------------------------------------------------------- Appendix III:4
The current funding provision designed to improve funding in
underfunded pension plans is not particularly effective. Most
underfunded plans are not subject to this provision because they have
fewer than 101 participants. Sponsors of less than half the large
underfunded plans subject to this provision were making additional
contributions in 1990 because allowable offsets eliminated any
additional contributions that otherwise would have been made. The
offsets also substantially reduced the additional contributions for
most of the sponsors that made them.
The offset provision is poorly designed in our opinion because it is
not equal to the payment the plan's sponsor is actually making to the
FSA to reduce plan underfunding. FSA amortization credits are
generally not incorporated into the offsets. The unanticipated flaw
in the current offset design results in offsets that can be several
multiples of the DRC for many plans. Because of this, many
underfunded plans will never receive additional contributions from
their sponsors unless the current offset provision is changed.
We also examined two other features of the additional contribution
provision to determine what impact they have on the size of
additional contributions that sponsors of underfunded plans make.
Splitting the plan's underfunding into old and new components has the
second largest effect on the size of additional contributions after
the offset provision. Combining the two underfunding components and
treating the total as unfunded new liabilities are now treated would
increase the number of sponsors making additional contributions by
almost 50 percent and the size of the additional contributions made
by 300 percent. Modifying the current interest rate range has the
least effect. Substantial reductions in the allowable interest rate
range would be needed to have an appreciable effect on the number of
plan sponsors making additional contributions or the size of total
additional contributions.
MATTERS FOR CONSIDERATION
------------------------------------------------------- Appendix III:5
Because of persistent and growing underfunding in certain pension
plans insured by the PBGC, the Congress should consider increasing
funding requirements to bolster contributions for underfunded plans.
This can be partially accomplished by correcting the design flaw in
the current offsets, but many underfunded plans will continue to
receive no additional contributions with this correction alone.
Therefore, the Congress may wish to consider limiting the size of the
offset that plan sponsors can use to reduce their additional
contributions. For example, if the Congress limited the offset to be
no greater than 80 percent of the DRC, then sponsors of every
underfunded plan would make an additional contribution to improve
their plan's funding of at least 20 percent of their DRC.
ANALYSIS OF THE PROPOSED PENSION
FUNDING IMPROVEMENT ACT OF 1993
========================================================== Appendix IV
This appendix describes our analysis of the probable effects of the
proposed funding rule changes contained in the Pension Funding
Improvement Act of 1993 (H.R. 298/S. 105). The PFIA would replace
the current funding provisions with a requirement that sponsors of
underfunded plans base their contributions on the greatest of three
funding provisions--the ERISA requirement (the current funding
requirement for most plans), the underfunding reduction requirement
(a proposed new funding requirement based primarily on the level of
underfunding in the plan), and the solvency maintenance requirement
(a proposed new funding requirement based primarily on disbursements
from the plan). The URR and SMR values could be reduced by
prescribed offsets before the plan sponsor determines the appropriate
funding requirement. (See app. I for details on the provisions in
these bills.)
ANALYSIS
-------------------------------------------------------- Appendix IV:1
The PFIA would restrict the range of allowable interest rates that
could be used to calculate current plan liabilities to the lower half
of the current range. This would raise the calculated liabilities of
the 24 plans in our 93-plan sample that currently select an interest
rate from the top half of the current range. We estimated that, if
this restriction had been in effect in 1990, 59 of these 93 plans
would have been subject to the proposed funding provisions of these
bills instead of the 57 subject to current law additional
contribution provisions. The analysis that follows is based on this
subsample of 59 plans.
Enactment of PFIA would reduce the number of sponsors of unfunded
plans who are making increased contributions compared with current
law, but it would substantially increase the amount of the
contributions those affected would pay (see table IV.1).\38 The new
proposals would cause sponsors of 16 plans to make contributions
greater than the ERISA requirement. These 16 sponsors include only 6
of the 22 sponsors making additional contributions under current
law.\39 Total contributions for these 16 plans would increase from
$17.4 million under the ERISA requirement to $62.1 million under the
applicable URR or SMR.
Table IV.1
Impact of PFIA on the Funding of 59
Plans, With and Without the Offset
Provision
Increase in
Contributions due contributions
under the ERISA under relevant Number of plans
Relevant provision funding provision paying under
funding (millions of (millions of relevant
provision dollars) dollars) provision
---------- ---------- ------------------ ------------------ ----------------
Contributi Total $38.8 $44.7 59
ons with
offset
provision
ERISA 21.4 0.0 43
URR 0.8 0.3 2
SMR 16.5 44.5 14
Contributi Total $38.8 $95.5 59
ons
without
offset
provision
ERISA 7.5 0.0 16
URR 2.7 2.4 11
SMR 28.6 93.1 32
--------------------------------------------------------------------------------
Notes: Dollar values may not sum to totals due to rounding.
The data in this table are based on the assumption that the SMR
5-year phase-in period is not in force.
The SMR, based on plan disbursements, will cause more sponsors to
make increased contributions than the URR, which is based on the
funding ratio of the plan. The 14 plan sponsors who would contribute
under the SMR provision would contribute $44.5 million more than
their ERISA requirement, a 269-percent increase.\40 Five of 14
sponsors who would pay under the SMR provision would have to
contribute at least twice as much as they would under the ERISA
requirement, and two such sponsors would experience more than a
fivefold increase in contributions (see table IV.2).
Table IV.2
Number of Plans by Percentage Increase
in URR and SMR Contributions Over ERISA
Contributions, With and Without the
Offset Provision
Average
Effective 500% increase in
funding No 0%- 51%- 101%- 201%- or contribution
provision increase 50% 100% 200% 500% more s
-------------- ---------- ------ ------ ------ ------ ------ ------------
With offsets
--------------------------------------------------------------------------------
ERISA 43 - - - - - 0%
URR - 2 0 0 0 0 30%
SMR - 5 4 1 2 2 269%
Total 43 7 4 1 2 2 115%
Without offsets
--------------------------------------------------------------------------------
ERISA 16 - - - - - 0%
URR - 6 3 1 1 0 91%
SMR - 11 5 7 3 6 326%
Total 16 17 8 8 4 6 246%
--------------------------------------------------------------------------------
Note: A "" indicates that the specified percentage increase cannot
occur with the designated effective funding provision.
By comparison, the two sponsors contributing under the URR provision
would have increased contributions of $0.2 million, about a
30-percent increase in contributions. Neither of these sponsors
would have a contribution increase as high as 50 percent.
Figure IV.1 shows the total contributions for the 59 plans under (1)
current law; (2) the ERISA requirement (the normal contribution
requirement used here as the base against which the other provisions
are compared); (3) the higher of the ERISA or URR contribution; (4)
the higher of the ERISA or SMR contribution; and (5) the highest of
the ERISA, URR, or SMR contribution. Most of the increase in total
contributions that would occur would be attributable to the 14
sponsors that would make contributions under the SMR provision. The
increase in the required contribution for these 14 sponsors would be
sufficient to more than double the total contributions going to all
59 underfunded plans in our sample.
Figure IV.1: Effect of Funding
Proposals on Contributions to
59 Underfunded Pension Plans,
With and Without Offsets
(See figure in printed
edition.)
Note: Based on GAO sample of 59 underfunded pension plans (in 1990).
If plans paid only the greater of the ERISA or URR contribution,
total contributions would increase by only 1 percent (see table
IV.3). And only 4 plans would be affected, far fewer than the 22
plans receiving additional contributions under current law. Current
additional contribution provisions, in contrast, increase total
contributions of the 59 plans by 7 percent over the ERISA
requirement.
Table IV.3
Number of Plans by Percentage Increase
Paying Under ERISA, URR, and SMR, With
and Without the Offset Provision
Effective 500% Average
funding No 0%- 51%- 101%- 201%- or increase in
provision increase 50% 100% 200% 500% more contributions
------------ ---------- ------ ------ ------ ------ ------ --------------
ERISA requirement versus the URR
--------------------------------------------------------------------------------
With offsets
--------------------------------------------------------------------------------
ERISA 55 - - - - - 0%
URR - 3 1 0 0 0 38%
Total 55 3 1 0 0 0 1%
Without offsets
--------------------------------------------------------------------------------
ERISA 27 - - - - - 0%
URR - 15 7 6 4 0 99%
Total 27 15 7 6 4 0 73%
ERISA requirement versus the SMR
--------------------------------------------------------------------------------
With offsets
--------------------------------------------------------------------------------
ERISA 45 - - - - - 0%
SMR - 5 4 1 2 2 269%
Total 45 5 4 1 2 2 115%
Without offsets
--------------------------------------------------------------------------------
ERISA 20 - - - - - 0%
SMR - 15 7 8 3 6 310%
Total 20 15 7 8 3 6 243%
--------------------------------------------------------------------------------
Note: A "" indicates that the specified percentage increase cannot
occur with the designated effective funding provision.
--------------------
\38 PFIA provides for a 5-year phase-in of the SMR. Twenty percent
of the excess of the SMR over the URR would be counted in each of the
first 5 years after enactment. The analysis presented here assumes
no phase-in period and indicates how the 59 plans would be affected
if they had their 1990 funding characteristics once the provisions of
the bills are fully phased in.
\39 See appendixes I and III for descriptions of how additional
contributions are calculated under current law. Under PFIA, the plan
sponsor would compare his contributions requirement under three
alternatives and pay the greatest amount. The current law paradigm
and the PFIA paradigm affect plans differently.
\40 Only five of the sponsors would make a contribution under the SMR
provision during the first year of the 5-year phase-in. The other
nine would make contributions based on the ERISA requirement. The
required contributions of the five sponsors who would be subject to
the SMR provision in the first year would increase from $7.4 million
(the ERISA requirement) to $10.9 million (the SMR requirement), a
48-percent increase.
AGGREGATIVE IMPACT OF PFIA
WITHOUT OFFSETS
------------------------------------------------------ Appendix IV:1.1
Removing the proposed offset provision of PFIA would more than double
the number of sponsors making additional contributions compared to
the number that would make them if the offsets were allowed. Total
contributions for the 43 affected plans would increase from $31.2
million under the ERISA rules alone to $126.7 million. Again, the
SMR would be the dominating provision, applying to sponsors of 32 of
the 43 plans and accounting for 97.5 percent of the $95.5 million
increase in contributions over the ERISA requirement.
Fifty-five percent of those who would pay under the URR provision
would make contributions that increased by less than 50 percent from
the ERISA requirement levels while half those who would pay under the
SMR provision would see their contributions more than double. One
sponsor paying under the SMR provision would find that its
contributions would increase by almost 900 percent, from the current
$3.2 million under the ERISA requirement to over $32 million.
EFFECTS ON MATURE VERSUS
YOUNG PLANS
------------------------------------------------------ Appendix IV:1.2
The SMR provision will have a larger impact on mature plans than on
young plans. We define mature plans as plans in which retiree
liabilities account for 40 percent or more of total liabilities. Our
59-plan sample of underfunded plans contains 22 mature plans and 37
young plans.
PFIA would increase the contributions to mature plans in our sample
by 175 percent over their base ERISA contributions. By contrast, the
contributions to young plans in the sample would increase by only 5
percent. Half of the mature plan sponsors in our sample would make
increased contributions while less than 15 percent of the sponsors of
young plans would.
Eliminating the offsets would markedly increase the number of
sponsors of both mature and young plans who make contributions under
the SMR provision (to 21 of the 22 mature plans and 22 of the 37
young plans). On the basis of our sample, if there were no offsets,
sponsors of mature plans would experience a 360-percent increase in
contributions compared with a 35-percent increase for sponsors of
young plans.
EFFECTS ON FLAT BENEFIT
PLANS VERSUS NONFLAT BENEFIT
PLANS
------------------------------------------------------ Appendix IV:1.3
Analysis of the 35 flat benefit plans and 24 nonflat benefit plans in
our sample shows that PFIA in its current form will have a somewhat
larger impact on flat plans than on nonflat plans. PFIA would
increase contributions to our sample of flat plans in aggregate by
approximately 140 percent. The increase for sample nonflat plans
would be about 90 percent. By contrast, excluding the offset
provision of PFIA would increase the contributions to sample flat
plans by approximately 290 percent and to sample nonflat plans by
about 210 percent. Thus, PFIA would appear to have a greater impact
on flat benefit plans, the plans most likely to be underfunded
because benefits are often regularly increased through plan
amendments.
CONCERNS ABOUT THE IMPACT OF
PROPOSED FUNDING RULES IN PFIA
-------------------------------------------------------- Appendix IV:2
CONCERNS WITH THE OFFSET
PROVISION
------------------------------------------------------ Appendix IV:2.1
The amortization charges and credits included in the offsets under
PFIA are precisely those that are not included in the current law
offsets. In addition, allowing an offset "for amounts considered
contributed by the employer
. . . to the extent necessary to avoid an accumulated funding
deficiency" (Sec. 102(d)) suggests that, if there were no
amortization charges and credits and no prior-year credit balance,
the contribution requirement under URR or SMR, before the offset,
would have to be at least twice the ERISA contribution for the
sponsor to make an increased contribution.
In addition, the amortization charges and credits could phase out by
2017, but the "amounts considered contributed" component of the
offset is not designed to phase out, so the proposed offset would be
in effect indefinitely.
We contacted individuals who designed the offset to determine why it
was designed as it was and how they intended it to work. One of
these people told us that the proposed offset may be "defectively
constructed" and would not be included in any revision of the
legislation.
In our opinion, the requirement that sponsors pay the greatest of the
contributions required under three distinct funding requirements
makes an offset provision unnecessary. The offset provision under
current law is designed to account for payments that the sponsor is
already making to reduce its plan's underfunding. However, these
payments are already accounted for by the ERISA contribution under
the proposal. Therefore, a modified offset like the one proposed to
replace the current law offset is unnecessary.
CONCERNS WITH THE SMR
------------------------------------------------------ Appendix IV:2.2
The proposed SMR is an especially powerful tool for increasing plan
funding. We are concerned, however, about three aspects of this
requirement.
First, the proposed SMR is not based primarily on either the level of
underfunding in the plan or the plan's funding ratio. The primary
component of the SMR for most plans affected by this provision will
be plan disbursements. For most plans, the major component of
disbursements is benefit payments. What is not recognized in this
provision is that $1 of benefit payments reduces both assets and
liabilities by $1. The only portion of the benefit payment that
needs to be replaced to maintain the plan's funding ratio is the
unfunded portion, not the entire payment. If the funding ratio is to
improve, more than this replacement amount must be contributed to the
plan. However, the SMR provision, as written, is overly punitive.
It could require two sponsors with equal disbursements to make equal
contributions to their underfunded plans, even if one plan were
significantly better funded than the other. Perversely, the SMR will
have a larger impact on a better funded underfunded plan than on a
worse funded one because contributions in excess of the amount needed
to replace unfunded disbursements will be larger for the former.
Second, the proposed SMR places a larger burden on underfunded mature
plans than on equally underfunded young plans. Because mature plans
will be making more benefit payments, their disbursements, and hence
required contributions, will be higher.
Finally, the proposed SMR produces contribution requirements that can
be several multiples of current contribution requirements and could
pose a large burden to some plan sponsors, even though their plans
are only slightly underfunded.
Sponsors affected by this provision would be required to pay plan
disbursements out of their current cash flow instead of from plan
assets, essentially forcing them into a pay-as-you-go funding
situation. This requirement that affected sponsors fund benefit
payments from current cash flow, regardless of how well funded their
plan is, could pose special difficulties for financially troubled
sponsors experiencing cash flow problems.\41
--------------------
\41 These sponsors could apply for a funding waiver from the IRS if
the situation warranted.
PLAN AMENDMENTS THAT
INCREASE UNDERFUNDING
------------------------------------------------------ Appendix IV:2.3
PFIA would require sponsors of underfunded plans granting a benefit
increase through plan amendment to provide security if the plan's
funding ratio after the amendment was less than 90 percent. The
amount of the security would be the excess over $1,000,000 of the
amount necessary to bring the funding ratio, including the unfunded
current liability attributable to the plan amendment, to 90 percent.
We did not determine how this provision might affect the plans in our
sample. All 93 plans could be affected, but we believe flat benefit
negotiated plans (at least 33 of the 45 flat benefit plans in our
sample) would be the most affected because these are the plans most
likely to receive regular periodic benefit increases.\42
We acknowledge the problem that such benefit increases cause and the
increased exposure they pose for PBGC. However, the proposed
solution will fall most heavily on one type of plan--negotiated flat
benefit plans--and can be expected to retard benefit growth for their
participants. Benefits in plans with salary-based benefits will
increase automatically with increases in the participants' earnings,
but most will not be affected by this provision. Underfunding
arising in flat and nonflat benefit plans or negotiated and
nonnegotiated plans should be addressed by the same set of rules as
much as possible.
The best solution to the problem of benefit increases is to correct
and strengthen the current additional contribution provision so that
a greater proportion of underfunded plans receive additional
contributions from their sponsors. Increases in plan liability from
benefits provided through plan amendment will be included in the
plan's unfunded new liability and subject to speedier amortization
under the improved additional contribution provision. In addition,
allowing sponsors of negotiated plans to advance fund their plans up
to perhaps 120 or 125 percent of current liability without penalty
could help alleviate the large increase in underfunding that occurs
whenever benefit increases are negotiated.
--------------------
\42 Four salary plans and four salary/flat benefit combination plans
in our sample are also negotiated plans.
ANALYSIS OF THE PROPOSED
RETIREMENT PROTECTION ACT OF 1993
=========================================================== Appendix V
This appendix describes our analysis of the probable effects of the
proposed funding rule changes contained in the Retirement Protection
Act of 1993 (H.R. 3396/S. 1780). The RPA's funding rule proposals
include, among others (1) a solvency rule for plans with liquid
assets equal to less than 3 years' disbursements, (2) a correction of
the offset design, and (3) an increase in the deficit reduction
contribution. (See app. I for details on the provisions in these
bills.)
The RPA moves in the right direction to strengthen funding in
underfunded plans and will result in substantial improvements over
current law, but, in our opinion, does not go far enough. Many
underfunded plans will continue to receive no additional
contributions to bolster their funding if this bill is enacted. The
RPA could and should be strengthened so that sponsors of a larger
percentage of underfunded plans make additional contributions to
bolster their plans' funding.
ANALYSIS
--------------------------------------------------------- Appendix V:1
Enactment of RPA would increase both the number of plans subject to
the additional contribution provision and the number of sponsors
required to make additional contributions. However, the transitional
provision that would limit the size of the additional contribution
would initially limit the number of sponsors making additional
contributions to about 50 percent of those subject to the provision.
CHANGES IN ACTUARIAL
ASSUMPTIONS
------------------------------------------------------- Appendix V:1.1
The RPA would restrict the allowable interest rate range that plans
could use when calculating their current liabilities to the same
range specified in the Pension Funding Improvement Act (H.R. 298/S.
105). Twenty-four of the 93 plans in our sample would have increased
current liabilities because of this restriction. RPA would also
restrict the mortality table that plans could use for calculating
current liabilities to the commissioner's standard mortality table
that would be used to determine reserves for group annuity contracts.
We were able to adjust plan liabilities for these mortality table
differences for 50 of the 93 plans in our sample.\43 Twenty-nine of
the remaining 43 plans already used the specified mortality table.
We did not have sufficient data for the 14 remaining plans to make
this adjustment.
Liabilities would increase for 62 of the 93 plans as a result of the
restrictions on interest and mortality rates. Underfunding would
increase for 38 of the 57 plans subject to the provision under
current law. Eight additional plans would also become underfunded
and subject to the additional contribution provision. The analysis
in the remainder of this appendix is based on this sample of 65
plans. Thirty-nine of these 65 plans are flat benefit plans and 26
are nonflat benefit plans.
--------------------
\43 To make this adjustment, we calculated the present value, at
single year ages through the plan's retirement age, of a $1 annuity,
payable monthly, using the plan's actuarial assumptions and again
using the plan's assumptions but substituting the commissioner's
mortality table. We multiplied the current liability for retirees by
the ratio of these present values at the plan's retirement age and
for nonretirees by the ratio at an age 15 years younger than the
plan's retirement age.
PROPOSED SOLVENCY RULE
------------------------------------------------------- Appendix V:1.2
RPA contains a provision that would require underfunded plans to
maintain liquid assets equal to at least 3 years' worth of plan
disbursements. If liquid assets fall below this amount, sponsors
would be required to make a solvency contribution to bring assets up
to that amount.\44 We estimate that only one of the plans in our
sample would be affected by this provision. We much prefer this
solvency rule to the SMR proposed in PFIA as a method of curtailing a
sponsor's ability to defund its plan during an economic hardship.
--------------------
\44 If only certain types of assets are counted as meeting the
proposed solvency rule, then this rule may affect plans' portfolio
management.
CALCULATING THE NEW
ADDITIONAL CONTRIBUTION
------------------------------------------------------- Appendix V:1.3
The RPA would modify the method of computing the DRC in several ways.
First, the increase in liabilities from restricting the interest and
mortality rate assumptions would be added to the unfunded old
liability and amortized over 12 years beginning in 1995. Second, the
unfunded new liability amount would be increased for all sponsors
whose plans' funding ratios exceed 35 percent. Finally, the DRC
would include a new component, the expected value of benefit accruals
for the plan year, in addition to the unfunded old and new liability
amounts.
The offset amount would also be modified under RPA. It would include
all amortization charges and credits, which would correct the design
flaw we found in the current law offset. It would also include the
plan's normal costs.
A plan's normal costs may not be equal to the expected value of
accrued benefits for the plan year because they can be calculated
using different interest rates and the normal costs will depend on
the funding method the plan uses. If the two values are equal, they
will cancel each other out when the offsets are subtracted from the
DRC. If they are not equal, the additional contribution will be
larger (when expected benefit accruals are larger than normal costs)
or smaller than if these amounts had been excluded from the DRC and
offset. When the amounts differ, the difference can be viewed, and
justified, as the amount needed to adjust the normal costs to a
current liability basis.
For 30 of the 65 underfunded plans in our sample, normal costs
exceeded expected benefit accruals. For these 30 plans, additional
contributions would be higher, or the probability of making
additional contributions would be greater, if normal costs and
expected benefit accruals were not included in the offset and DRC,
respectively. However, an almost equal number, 27 plans, have
expected benefit accruals that exceed normal costs. Sponsors of
these plans would be more likely to make additional contributions
under the proposal as written. For the remaining eight plans, normal
costs equal expected benefit accruals.
We estimate that, if the transitional limitations in the bill were
not in effect, sponsors of 38 of the 65 plans that would be subject
to the additional contribution provisions under RPA would make $29.2
million in additional contributions. These limitations, which would
be in effect through the 2001 plan year, would restrict the
additional contribution to be no greater than the larger of the
additional contribution that would be required under current law or
the additional contribution that would be required to increase plan
funding by no more than a specified percentage increase.
These limitations would initially eliminate any additional
contributions for 4 plans and would reduce them for 11 others. With
the limitations in effect, 34 sponsors would make additional
contributions of $28.0 million. Only 16 of the 22 sponsors making
additional contributions under current law would make them under RPA
and 6 of these 16 sponsors would pay less. The average additional
contribution under RPA would be more than six times the average
amount paid under current law, however (see table V.1).\45
Table V.1
Comparison of the Additional Funding
Provision Under Current Law and RPA,
Based on a Sample of 93 Plans
Curren
t law RPA
---------------------------------------------- ------ ----
Number of plans with unfunded current 57 65
liabilities
Number of plans whose sponsors are making, or 22 34
would make, additional contributions
Amount of additional contributions (dollars in $2.8 $28.
millions) 0
Average additional contribution (dollars in $127.7 $823
thousands) .8
------------------------------------------------------------
Twenty-three of the 34 plans that would receive additional
contributions with the transition rules in place are flat benefit
plans, but they receive only half of all additional contributions.
Without the transition rules, half of all additional contributions
would continue to go to flat benefit plans even though 27 of the 38
plans that would receive additional contributions are flat benefit
plans.
Under RPA initially, sponsors of about half the underfunded plans
would not be making additional contributions to improve funding in
their plans.\46 Sponsors of all nine plans in our sample with funding
ratios below 50 percent would make additional contributions if the
RPA is enacted, but only about half of the 31 plans that are 50- to
80-percent funded would do so. Moreover, the additional contribution
for five of the nine most underfunded plans would be less than 5
percent of the underfunding at the beginning of the plan year. We
conclude that additional strengthening of the additional contribution
provision, beyond that contained in the RPA, is needed to ensure that
sponsors of most underfunded plans make additional contributions to
improve their plans' funding.\47
--------------------
\45 Should the sponsor experience financial hardship because of the
increase in required contributions (a maximum increase of 283 percent
in our sample), the sponsor can apply for a funding waiver from IRS.
\46 The 95-percent confidence interval indicates that between 39 and
65 percent of underfunded plans subject to the RPA provisions would
receive additional contributions.
\47 We note that such a strengthening will invoke PAYGO
considerations that the Congress will have to address.
SENSITIVITY ANALYSIS
--------------------------------------------------------- Appendix V:2
A number of modifications to the RPA could be used to increase the
number of sponsors of underfunded plans that make additional
contributions. Table V.2 shows the estimated impact of six such
modifications.
Table V.2
The Number of Sponsors Making Additional
Contributions and the Size of These
Contributions Under Various
Modifications to RPA, Based on a Sample
of 65 Underfunded Plans
Numb Thousands of Thousands of
Modification er dollars Number dollars
-------------------------------------- ---- ------------ ------ ------------
No modification 34 $28,010 38 $29,241
Offsets exclude normal costs 37 25,590 39 26,856
No old underfunding 42 42,171 46 56,864
Limit offsets to 90% of DRC 61 28,690 61 30,244
Eliminate offsets 61 49,610 61 62,879
Limit offsets to 90% of DRC for plans 49 28,542 49 29,729
that are less than 80% funded
Limit offsets to 50% of DRC for plans 49 31,781 49 35,086
that are less than 80% funded
--------------------------------------------------------------------------------
If normal costs were excluded from the offset and expected benefit
accruals were excluded from the DRC, the number of sponsors of
underfunded plans in our sample who initially would make additional
contributions would increase from 34 to 37, but total additional
contributions would decline slightly.
Treating all underfunding as new underfunding and subjecting it to
the proposed provisions would increase the number of sponsors making
additional contributions by about 25 percent, to 42. Total
additional contributions would increase by about 50 percent to $42
million. This illustrates the large impact the transition rule of
splitting underfunding into old and new components has on the size of
additional contributions. Because this transition rule is scheduled
to phase out in 2006, it does not need to be modified, in our
opinion.
Six of the eight sponsors that would begin making additional
contributions if all underfunding were treated as new underfunding
have plans that are 50- to 75-percent funded, and seven of the eight
are sponsors of flat benefit plans. Without the proposed
transitional limitations, this change would require sponsors of 46 of
the 65 underfunded plans to make total additional contributions of
$57 million, 23 percent of the beginning-of-year underfunding in
these 46 plans.
The final four modifications shown in table V.2 would limit the
offset that could be used to reduce the DRC. In the first of these,
the offset would be limited to a maximum of 90 percent of the DRC,
and in the second the offset would be eliminated. In each instance,
61 of the 65 sponsors of underfunded plans would make additional
contributions.\48 In the other two modifications, the offset would be
limited (to 90 and 50 percent of the DRC, respectively) only for
plans that were less than 80-percent funded. In these cases, 49 of
the 65 sponsors of underfunded plans would need to make additional
contributions.
Limiting the offset to 90 percent of the DRC for all underfunded
plans would have only a small impact on the total amount of
additional contributions received (about a 2.5-percent increase for
our sample) but would cause nearly all sponsors of underfunded plans
to make an additional contribution. Thirty-one of the 34 sponsors
that would make additional contributions under the RPA as proposed
would not have increased additional contributions under this
modification because the offsets for their plans are already less
than 90 percent of their DRCs. The additional contribution under
this modification would equal less than 2 percent of the
beginning-of-year underfunding for 21 of the 61 affected plans, so it
would not likely pose a hardship for most sponsors.
More severe restrictions on the offset would result in increased
additional contributions for an increasingly larger portion of the
affected sponsors. In the extreme case where there is no offset,\49
total additional contributions for the 61 affected sponsors in our
sample would climb to nearly $50 million, almost 20 percent of the
beginning-of-year underfunding in these 61 plans.
If the Congress decides that the RPA would not cause enough sponsors
of underfunded plans to make additional contributions, and it does
not want to burden all such sponsors with making additional
contributions if their plans are only slightly underfunded, it can
specify a threshold funding ratio below which the offset would be
limited. For example, the Congress could decide that sponsors of all
plans that were less than 80-percent funded would make some
additional contributions to improve their plans' funding, but that
sponsors of plans 80-percent funded or better would make additional
contributions only if their unrestricted offsets were insufficient to
eliminate their plans' DRCs.
If the funding ratio threshold were set at 80 percent and offsets
were restricted to be no greater than 90 percent of the DRC, then 49
sponsors in our sample would make $28.5 million in additional
contributions. This is less than a 2-percent increase in total
additional contributions over the RPA as proposed, but the number of
sponsors making additional contributions would increase by almost 45
percent. Obviously, as the limit on the offset is reduced,
additional sponsors would be affected and the total amount of
additional contributions would increase. If the sponsors of plans
that are less than 80-percent funded had their offsets capped at 50
percent of their DRC, then the same 49 sponsors in our sample would
make total additional contributions of $31.8 million, about a
13-percent increase over the current RPA proposal.
Again, we note that modifying the RPA to increase the percent of
sponsors of underfunded plans that would make additional
contributions will result in a PAYGO issue. We estimated that the
incremental revenue loss from a reasonable modification will be small
(for example, about $60 million if the offset were limited to 50
percent of the DRC for plans that were less than 80-percent funded).
The Congress will have to balance the budget's PAYGO considerations
against the improved protections for PBGC and plan participants when
deciding whether or by how much the RPA should be strengthened.
--------------------
\48 We estimate that the other four sponsors would make sufficient
contributions to bring their plans to full funding without any
additional contributions.
\49 We do not advocate this extreme case but present it only to
illustrate how powerful the offset would remain under the RPA.
CONCERNS ABOUT THE RPA
--------------------------------------------------------- Appendix V:3
We have several concerns about the RPA. On the basis of our
analysis, we find the RPA will not require increased contributions
for many sponsors of underfunded plans. If the RPA had been in
effect in 1990, almost half the sponsors with plans subject to the
revised additional contribution provision would not have made
additional contributions to reduce their plans' underfunding. Even
if the transitional limitations were not in effect, more than 40
percent of the sponsors in our sample with underfunded pension plans
would not have made additional contributions. Additional actions,
such as limiting the offset to a percentage of the DRC, are necessary
if underfunding is to be speedily reduced in most underfunded plans.
We are concerned with the impact the transitional limitation will
have on the number of sponsors initially making additional
contributions and the size of those contributions. At a minimum, the
design flaw in the current law offset should be corrected before the
current law's additional contribution requirement is used as a
limitation.
In addition, we believe the limitations on the percentage increases
in plan funding contained in the alternative transitional limitation
are too low. If this were the sole transitional limitation, only 24
sponsors would make additional contributions, and 9 of these would
make additional contributions smaller than those they would make
without this limitation. This compares with the 38 sponsors that
would make additional contributions in the absence of any
transitional limitations. In our view, the restriction on the
increase in a plan's funding ratio is too limiting. We believe that
the cap should be set 2 or 3 percentage points higher than proposed
in the RPA. All 38 sponsors that would make additional contributions
in the absence of any transitional limitations would make additional
contributions with the limitations in place if the caps were set 3
percentage points higher.
If target increases in funding are to be used, we prefer that,
instead of limiting additional contributions by a maximum increase in
a plan's funding ratio, a minimum increase in this ratio be adopted.
If minimum contributions in the absence of additional contributions
are not sufficient to increase the plan's funding ratio by the
specified percentage (which could be dependent on the plan's
beginning-of-year funding ratio), then an additional contribution
sufficient to attain the target would be required.
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix VI
Don Snyder, Assistant Director, (202) 512-7204
Michael Packard, Project Manager
Donna Berryman
Anindya Bhattacharya
Debra Conner
Jeremy Cox
Shannon Cross
Ronald Haun
Sherrill Johnson
Carolina Martinez
Sheila Murray
Charles Vrabel
John Wood